The 4-year project requires equipment that costs $60,000. If undertaken, the share- holders will contribute $55,000...

Transcribed Image Text:

The 4-year project requires equipment that costs $60,000. If undertaken, the share- holders will contribute $55,000 cash and borrow $5,000 at 5% with an interest-only loan with a maturity of 4 years and annual interest payments. The equipment will be depreciated straight-line over the 4-year life of the project. There will be a pre-tax salvage value of $5,000. There are no other start-up costs at year 0. During years 1 through 4, the firm's before-tax operating cash flow will be 20,000. i = rdebt = 5%, Ku = 7%, K = TWACC = 6.5% Debt-to-equity ratio = 3 Risk-free rate 2% T = Tax rate= 34% CF0 = $60,000 CF1-4 =$17,875 = 20,000 x (1 0.34) + $13,750 × 0.34 T OCF1--4 1-T D₁--4 For year 4, on top of $17,875, there is also TV4 =$5,000×(1-34) (a) What is the NPV of the project using the WACC methodology? (b) What is the PV of after-tax operating CF of the project using the APV method- ology? (c) What is the PV of depreciation tax shield using the APV methodology? (d) What is the PV of interest tax shield using the APV methodology? (e) Finally what is the NPV of the project using the APV methodology? The 4-year project requires equipment that costs $60,000. If undertaken, the share- holders will contribute $55,000 cash and borrow $5,000 at 5% with an interest-only loan with a maturity of 4 years and annual interest payments. The equipment will be depreciated straight-line over the 4-year life of the project. There will be a pre-tax salvage value of $5,000. There are no other start-up costs at year 0. During years 1 through 4, the firm's before-tax operating cash flow will be 20,000. i = rdebt = 5%, Ku = 7%, K = TWACC = 6.5% Debt-to-equity ratio = 3 Risk-free rate 2% T = Tax rate= 34% CF0 = $60,000 CF1-4 =$17,875 = 20,000 x (1 0.34) + $13,750 × 0.34 T OCF1--4 1-T D₁--4 For year 4, on top of $17,875, there is also TV4 =$5,000×(1-34) (a) What is the NPV of the project using the WACC methodology? (b) What is the PV of after-tax operating CF of the project using the APV method- ology? (c) What is the PV of depreciation tax shield using the APV methodology? (d) What is the PV of interest tax shield using the APV methodology? (e) Finally what is the NPV of the project using the APV methodology?