Question

Roger has a levered cost of equity of 0.12. He is thinking of investing in a project with upfront costs of $5 million, which pays $3 million per year for the next 4 years. He is going to borrow $5 million to offset the startup costs at a rate of 0.05. His tax rate is 0.4. He will repay this loan at the end of the project. What is the NPV of this project, using the FTE method?

Answer 1

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. You can also understand the mathematics making use of [+] / [-] sign appearing in the first column. The last row highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $ mn. Adjacent cells in blue contain the formula in excel I have used to get the final output. The net cash flows are the cash flows to the equity holder (FTE).

0 394 Year Linkage 395 Project cash flows A 396 Loan B 397 (-) Interest C = -0.05 x 5 398 [+] Tax shield D = Cx 0.4 399 Net cash flows Sum of A to D 400 Cost of equity 401 NPV Excel formula L MN 12 (5.00) 3.00 3.00 3.00 5.00 (0.25) (0.25)| (0.25) 0.10 0.10 0.10 2.85 2.85 2.85 0.12 5.48 "=NPV(K400,L399:0399)+K399 3.00 (5.00) (0.25) 0.10 (2.15)

the NPV of this project, using the FTE method = $ 5.48 million