Gemini, Inc., an all-equity firm, is considering an investment of $1.67 million
ID: 2788264 • Letter: G
Question
Gemini, Inc., an all-equity firm, is considering an investment of $1.67 million that will be depreciated according to the straight-line method over its four-year life. The project is expected to generate earnings before taxes and depreciation of $601,000 per year for four years. The investment will not change the risk level of the firm. The company can obtain a four-year, 8.2 percent loan to finance the project from a local bank. All principal will be repaid in one balloon payment at the end of the fourth year. The bank will charge the firm $51,000 in flotation fees, which will be amortized over the four-year life of the loan. If the company financed the project entirely with equity, the firm’s cost of capital would be 14 percent. The corporate tax rate is 30 percent. Using the adjusted present value method, calculate the APV of the project. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Gemini, Inc., an all-equity firm, is considering an investment of $1.67 million that will be depreciated according to the straight-line method over its four-year life. The project is expected to generate earnings before taxes and depreciation of $601,000 per year for four years. The investment will not change the risk level of the firm. The company can obtain a four-year, 8.2 percent loan to finance the project from a local bank. All principal will be repaid in one balloon payment at the end of the fourth year. The bank will charge the firm $51,000 in flotation fees, which will be amortized over the four-year life of the loan. If the company financed the project entirely with equity, the firm’s cost of capital would be 14 percent. The corporate tax rate is 30 percent. Using the adjusted present value method, calculate the APV of the project. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)Explanation / Answer
Data given
Step - 1 Calculate the base case NPV ( i.e ignoring the impact of debt and interest)
Base case NPV
STEP - 2
Calculate the NPV of the tax saving on Interest and amortization of upfront costs during the life of the project.
Interest = 1670,000 * 8.2% = 136940
Annual amortization of flotation fee = 51000 / 4 = 12750
Total = 136940 + 12750 = 149690
Tax shield = 149690 * 0.30 = 44907
Now we compute the NPV of this tax shield as under ( using interest = discount rate)
ADJUSTED PRESENT VALUE (APV)
= Base case NPV + Tax shield NPV = -79,258.8 + 97077.93 = 17819.13................final answer
Investment 1,670,000 Depreciation = 1670,000/4 417500 EBITDA 601000 Required rate of return 14% Tax rate 30%Related Questions
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