Consider a project that requires an initial investment of $1,000,000 and has an expected cash-inflow of $85,000 a year in perpetuity

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Consider a project that requires an initial investment of $1,000,000 and has an expected cash-inflow of $85,000 a year in perpetuity. The opportunity cost of capital with an all equity financing structure is 10%, and the project allows the firm to borrow at 7%. Assume the corporate tax rate is 35%). Use the APV to estimate the project’s value.
a. Assume first that the project will be partly financed with $400,000 of debt and that the debt amount is to be fixed and perpetual
b. Then assume that the initial borrowing will be increased or reduced in proportion to changes in the future market value of this project.
(Hint: Notice that the discount rate for the tax shields that you’ll in a and b is not the same. In the first case, the tax shields are fixed and constant while in the second case they will be moving in sync with the operating assets.