Question

2. on pH valutar v e project! APV Gemini, Inc., an all-equity firm, is considering an investment of $1.4 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 $502,000 per year for four years. The investment will not change the risk level of the firm. The company can obtain a four-year, 9.5 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 $45,000 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 13 percent. The corporate tax rate is 30 percent. Using the adjusted present value method, determine whether the company should undertake the project.

Answer 1

The answer is -$2641451.5025
calculation of APV (Adjusted present volue) APV = NPV (All equity firm) + Nou (financing ade effects) The adjusted present value of a project equals to the NPV of the project under all equity financing + Nry of any francing Side effects. NPV (All equity) Intial investment $1.4 million which will be fully depreciate - ted over 4 year under sim so depreciation per year will be = 1400000/4 = $350000 this shooud be expensed off each year Tax rate - 30% & EBTDA is $502000 per year a EBTDA 500000 Do Tax @ 30% on (150 600) above 357400 d) PVAf@ 13% for 440s 2.9745 & cxd (351400 X 2,9745) = 1045 2.39.3 f) Pr of depreciation tax shield - 350000 X 0.30 X 2.9145 = 312322.5 . NPV = intial investment - [Prof cash + pv of deprol - flows tax shield] 1400000 - 1045239-3 + 312322.5] = 1400 000 - 1357561.8 = $ 42438.2

NPV (financing side effects) - This is equal to after tox PV of cash flows resungs from firm's clebt Given flotation cost of $45000/4 = + 11200 per year This cash flows from debt should be discounted at pre tax cost of debt ie 9.5% NP (financing side = Proceeds net 4 flotation (o) - (After to effects Pr of interest payments) (Pv of Principal payments) + Pv (floration cost tax Shield) (14000 - 45000) - (14000DO X0.095X0-0:30) X 3.2045) - 14000v/1.0958 +(9:30 X 50 X 3.2045) = 1355000 - 2983389.5 - 106631539 + 10%15.1875 - 2683889.7025 ... APV = NPV (au equity) + NPV (financing side effects) +424438.2 - 2683859-1025 - - 2641HSI.5025 Since APV of the project is negative the company Pe Gemini should not undertake the project