Zoso is a rental car company that is trying to determine whether to add 25 cars
ID: 2782963 • Letter: Z
Question
Zoso is a rental car company that is trying to determine whether to add 25 cars to its fleet. The company fully depreciates all its rental cars over five years using the straight-line method. The new cars are expected to generate $165,000 per year in earnings before taxes and depreciation for five years. The company is entirely financed by equity and has a 38 percent tax rate. The required return on the company’s unlevered equity is 13 percent, and the new fleet will not change the risk of the company. The risk-free rate is 5 percent.
What is the maximum price that the company should be willing to pay for the new fleet of cars if it remains an all-equity company? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Suppose the company can purchase the fleet of cars for $475,000. Additionally, assume the company can issue $405,000 of five-year debt at the risk-free rate of 5 percent to finance the project. All principal will be repaid in one balloon payment at the end of the fifth year. What is the adjusted present value (APV) of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Zoso is a rental car company that is trying to determine whether to add 25 cars to its fleet. The company fully depreciates all its rental cars over five years using the straight-line method. The new cars are expected to generate $165,000 per year in earnings before taxes and depreciation for five years. The company is entirely financed by equity and has a 38 percent tax rate. The required return on the company’s unlevered equity is 13 percent, and the new fleet will not change the risk of the company. The risk-free rate is 5 percent.
Explanation / Answer
Note: Tax shield on depreciation is discounted at the cost of debt.
a) Setting NPV = 0, we have 165000*(1-0.38)*PVIFA(13,5)+(P/5)*0.38*PVIFA(13,5)-P = 0 where 165000*(1-0.38)*PVIFA(13,5) = PV of the annual after tax EBITDA and (P/5)*0.38*PVIFA(13,5) = The PV of annual depreciation tax shield P being the Price that should be paid for the new fleet of cars. Solving for P 165000*0.62*3.51723+(P/5)*0.38*3.51723 - P = 0 359812.63+0.26731*P = P 359812.63 = P - 0.26731*P 359812.63 = 0.73269*P P = 359812.63/0.73269 = P = $491,084.05 Answer: Maximum price that can be paid = $491,084.05 b) NPV using unlevered cost of equity: After Tax EBITDA = 165000*0.62 = 102300 Depreciation tax shield = (475000/5)*0.38 = 36100 Incremental after tax annual cash inflows 138400 PV = 138400*3.51723 = $ 486,784.63 Less: Initial investment $ 475,000.00 NPV (using unlevered cost of equity) $ 11,784.63 Add: PV of tax shields = 405000*5%*0.38*PVIFA(5,5) = 7695*4.32948 $ 33,315.35 Adjusted PV $ 45,099.98 AnswerRelated Questions
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