Question

Rush has a levered cost of equity of 0.32. She is investing in a project with upfront costs of $6million, which pays $2 million per year for the next 4 years. He is going to borrow $7 million to offset the startup costs at a rate of 0.05. Her tax rate is 0.3. She will repay this loan at the end of the project. What is the NPV of this project, using the FTE method?

Answer 1

Given information:- levered Cost of Equity = ko = 0.32. Pnittal investment = $6 million Cash inflow = $2 million for next 4 years (unlevered Cosh flow) Cort of debt = kd = 0.05 Tan rate 0.3. First we need to find Levered Cash flow (LLF). For that we need to subtract Interent from the Unlevered cash flow (UCF). But we need to keep in mind that interent gives tax shield. so the formula will be S LLF = UCF-(1-A)rB. where, it= tan rate r = rate of interest B = Amount Borrowed. LCF = $2 million -(1-0-30) x0.05$ 7 milion = $2 million -(0.70) * $0.35 million S

-$2,000,000 -$245,000 = $1,755,000 To find net present value, the present value of initial Cach out flows are subtracted from present value of Cach inflows. First let us find the present value of Cach inflows : Cach inflours will be Levered cash flows in our care which we calculated as $1,755,000. LLF must be discounted at the rate of levered cost of equity (0.32) Formula : PV = 167 (90 where, PV = present value i= cost of equity n = number of periods Therefore, putting the values in the formulas we get PV = $1,755,000 [ 0.32(1+0.32)"}

= $1,755,000 (2.095671) = $3,677,902 Present value of Present value of cach autflows - $6,000,000 cash infloum = $3,677,902 Net Present Value - $ 3,677,902 - $ 6,000,000 = ($ 2,322,098) H is advised not to accept this project it does not satisfy the cost of Equity. because