Suppose a firm is considering a $20 million project in Seattle that will last 4 years. Assume
Question:
Suppose a firm is considering a $20 million project in Seattle that will last 4 years. Assume that cash revenues less cash expenses are $8.5 million for each of the 4 years. Additionally, assume that the corporate tax rate is 35 percent. The risk-free rate is 6%, and the unlevered cost of equity is 15%. Assume that the firm depreciates the initial investment straight-line to zero over the life of the project.
a. Calculate the All-equity value of the firm. You are doing this with a financial calculator and you must show and explain your steps. You must explain your choice(s) of discount rates. It is best if your equation is a sum of each part that you show the number for each piece of the PV, for maximum partial credit.
b.Now, assume that this same firm is granted a loan by the city of Seattle. Since the city of Seattle would really like the company to locate here, it is offering a subsidized loan of $10 million with zero flotation costs at an interest rate of 4%. Recall, municipalities can extend favorable loan rates to firms since they are able to borrow at rates lower than a comparable risk/term treasury.
Assume also this is a 4- year interest-only loan where the firm repays the entire principal at the end of the loan. Calculate the NPV of the loan. Calculate the APV of the project.
c.In your own words, what is unique about the APV method relative to the NPV method you used in Finance 350 and/or earlier in this course? What kind of cases does APV allow us to look at that the traditional method did not explicitly take into account? Explain your answer as if you were in an interview.
Principles Of Managerial Finance
ISBN: 978-0136119463
13th Edition
Authors: Lawrence J. Gitman, Chad J. Zutter