An all-equity rental car company is trying to determine whether to add cars to its fleet, The
Question:
An all-equity rental car company is trying to determine whether to add cars to its fleet, The firm fully depreciates all its rental cars over five years using the straight-line method. The new cars are expected to generate $140,000 per year in earnings before taxes and depreciation (EBTD) for five years. The company can purchase the fleet of cars for $395,000. The company has a 35% tax rate. The required return on the firm's unlevered equity is 13% and the new fleet will not change the risk of the company.
Assume that out of the $395,000 cost of the fleet, $260,000 will be financed with five-year debt. ?The pre-tax cost of debt is 8%. The interest will be paid each year but all principal will be repaid in one balloon payment at the end of the fifth year. What is the adjusted present value of the project? ignore flotation fees of the debt issue. Also ignore bankruptcy costs, transaction costs, and signaling, incentive, clientele and other effects.
Managerial Decision Modeling with Spreadsheets
ISBN: 978-0136115830
3rd edition
Authors: Nagraj Balakrishnan, Barry Render, Jr. Ralph M. Stair