Question

Roger has a levered cost of equity of 0.23. He is thinking of investing in a project with upfront costs of $10 million, which pays $3 million per year for the next 7 years. He is going to borrow $4 million to offset the startup costs at a rate of 0.03. His tax rate is 0.3. He will repay this loan at the end of the project. What is the NPV of this project, using the FTE method?

Answer 1

Answer:

NPV of this project, using the FTE method = -$231,821.89

NPV is negative and hence should be rejected.

Working:

1 2 3 5 Year Upfront Investment ($10,000,000) Borrowing $4,000,000 EBIT Interest on borrowing EBT Tax at 30% EAT $3,000,000 $3,000,000 $3,000,000 $3,000,000 $3,000,000 $3,000,000 ($120,000) ($120,000) ($120,000) ($120,000) ($120,000) ($120,000) $2,880,000 $2,880,000 $2,880,000 $2,880,000 $2,880,000 $2,880,000 ($864,000) ($864,000) ($864,000) ($864,000) ($864,000) ($864,000) $2,016,000 $2,016,000 $2,016,000 $2,016,000 $2,016,000 $2,016,000 $3,000,000 ($120,000) $2,880,000 ($864,000) $2,016,000 Repayment of borrowing ($4,000,000) Cash flow (FTE method) ($6,000,000) $2,016,000 $2,016,000 $2,016,000 $2,016,000 $2,016,000 $2,016,000 ($1,984,000) NPV at 23% discount rate ($231,821.89)