Question

Orange Valley Aviation is evaluating a 1-year project that would involve an initial investment in equipment of 29,200 dollars and an expected cash flow of 32,300 dollars in 1 year. The project has a cost of capital of 9.62 percent and an internal rate of return of 10.62 percent. If Orange Valley Aviation were to use 29,200 dollars in cash from its bank account to purchase the equipment, the net present value of the project would be 266 dollars. However, Orange Valley Aviation has no cash in its bank account, so using money from its account is not possible. Therefore, the firm would need to borrow money to raise the 29,200 dollars. If Orange Valley Aviation were to borrow money to raise the 29,200 dollars, the interest rate on the loan would be 6.69 percent. Orange Valley Aviation would receive 29,200 dollars from the bank at the start of the project and would pay 31,153 dollars to the bank in 1 year. What is the NPV of the project if Orange Valley Aviation borrows 29,200 to pay for the project?

Answer 1

Answer:

Given:

Orange Valley Aviation is evaluating a 1-year project that would involve an initial investment in equipment of 29,200 dollars and an expected cash flow of 32,300 dollars in 1 year.

If Orange Valley Aviation were to borrow money to raise the 29,200 dollars, the interest rate on the loan would be 6.69 percent.

There is no information on tax.

Hence: Cost of capital = 6.69%

Orange Valley Aviation would receive 29,200 dollars from the bank at the start of the project and would pay 31,153 dollars to the bank in 1 year.

NPV of the project if Orange Valley Aviation borrows 29,200 to pay for the project = 32,300 / (1 + 6.69%) - 29200 = $1074.63

Hence:

NPV of the project if Orange Valley Aviation borrows 29,200 to pay for the project = $1,074.63