Consider a project to produce solarwater heaters. It requires a$10 million investment and offers a level after-tax cash flow of $1.75 million per year for 10 years. The opportunity cost of capital is 12%, which reflects the project’s business risk.
a. Suppose the project is financed with $5 million of debt and $5 million of equity. The interest rate is 8% and the marginal tax rate is 35%. The debt will be paid off in equal annual installments over the project’s 10-year life. Calculate APV.
b. How does APV change if the firm incurs issue costs of $400,000 to raise the $5 million of required equity?
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