Question

12. APV MVP, Inc., has produced rodeo supplies for over 20 years. The company currently has a debt-equity ratio of 50 percent and is in the 40 percent tax bracket. The required return on the firm's levered equity is 16 percent. The company is planning to expand its production capacity. The equipment to be purchased is expected to generate the following unlevered cash flows: Year Cash Flow O $15,100,000 5,400,000 8,900,000 8,600,000 The company has arranged a debt issue of $8.7 million to partially finance the expansion. Under the loan, the company would pay interest of 9 percent at the end of each year on the outstanding balance at the beginning of the year. The company would also make year- end principal payments of $2,900,000 per year, completely retiring the issue by the end of the third year. Using the adjusted present value method, should the company proceed with the expansion?

Answer 1

12)

Total Year Debt outstanding Principal repayment After tax interest payment o$ 8,700,000 1 $ 5,800,000 $ 2,900,000 $ 469,800 2 $ 2,900,000 $ 2,900,000 $ 313,200 2,900,000 $ 156,600 $ 3,369,800 $ 3,213,200 $ 3,056,600 3 $

Year Cash flow PVIF @14.38% Present value 0 $ (15,100,000) 1 $ 5,400,000 2 $ 8,900,000 3 $ 8,600,000 1.000 $ 0.874 $ 0.764 $ 0.668 $ (15,100,000.00) 4,720,914.59 6,802,284.22 5,746,396.68 NPV $ 2,169,595.50 Unlevered cost of equity 14.38% =(16%+9%*(1-40%)*0.5)/(1+0.5*(1-40%)) Year Cash flow PVIF@9% Present value 0 $ 8,700,000 1 $ (3,369,800) 2 $ (3,213,200) 3 $ (3,056,600) 1.000 $ 0.917 $ 0.842 $ 0.772 $ 8,700,000.00 (3,091,559.63) (2,704,486.15) (2,360,256.03) NPV financing side affect 543,698.19 Adjusted NPV (APV) $ 2,713,293.69 =2169595.5+543698.19 Yes, Proceed with project.

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