question archive 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
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
Subject:BiologyPrice:3.87 Bought7
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.
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.
Purchase A New Answer
Custom new solution created by our subject matter experts
GET A QUOTE
Answer Preview
Answer :-
(A)first that the project will be partly financed with $400,000 of debt and
that the debt amount is to be fixed and perpetual?
Answer:-
FV = -$1,000,000
i = 10% = .10
Net present value (NPV) = Fv + cash flow/ rate
= -$1000000 + ($85000/.10)
= -$1000000 + $850000
= -$1,500,00
PV( tax shields ) is calculated as,
= 35% * 400000 = 140000
Therefore , APV = -$150000+$140000
= -$10000
(B) Then assume that the initial borrowing will be increased or reduced in proportion to changes in the future market value of this project.
Answer :
PV (tax shields, not fixed) :
35%*7% *4,00,000)/10% = $98000
APV = -1,50,000 +$98000 = - $52000
Wherenever debt isfixed , the present value of the tax shield is higher. Also, when there's a tax shield required .
The project's opportunity cost of capital must be discounted by taking into the account the uncertainty of the interest tax of the shields.
