Oliver ASA has an investment beta of 1.3, and the risk-free rate is 4%. The expe

Question

Oliver ASA has an investment beta of 1.3, and the risk-free rate is 4%. The expected return on the market portfolio is 11%, and the corporate tax-rate is 27%. There are no personal taxes. Oliver considers a new 3-year project. The project requires an investment of NOK 8 million. The project will be financed by 40% debt and cost of debt is 5%. The loan is fully repaid in the last year. The company expects an annual after-tax cash flow from this project of NOK 4 million in all 3 years. What is the present value of the project’s tax-shield? (answer: 0,1176 MNOK) What is the project's adjusted present value? (answer:1,5462 MNOK). This is all the information provided in the text.

Explanation / Answer

Interest payments = 40%*8*5% = 0.16

Annual tax shield = 0.27*0.16 = 0.0432

PV of tax shield = 0.0432/(1+5%) + 0.0432/(1+5%)2 + 0.0432/(1+5%)3

= 0.1176

=PV(5%,3,-0.0432) = 0.1176

Cost of equity = 4% + 1.3*(11-4%) = 13.1% (CAPM model Re = Rf + Beta*(Rm-Rf) )

NPV = -8 + 4/(1+13.1%) + 4/(1+13.1%)2 + 4/(1+13.1%)3 = 1.4286

Ajusted PV = NPV + PV of tax shield

= 1.4286 + 0.1176

   = 1.5462

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