NPV(Financing Side Effects)
The net present value of financing side effects equals the after-tax present value of cash
flows resulting from the firm’s debt.
NPV(Financing Side Effects)
= Proceeds – After-Tax PV(Interest Payments) –
PV(Principal Payments)
Given a known level of debt, debt cash flows should be discounted at the pre-tax cost of
debt (r
B
), 8%.
NPV(Financing Side Effects)
= $600,000 – (1 – 0.40)(0.08)($600,000)A
5
0.08
–
[$600,000/(1.08)
5
]
= $600,000 – 114,990.05 – 408,349.92 = 76,660.03
APV
APV = NPV(All-Equity) + NPV(Financing Side Effects)
= -$26,749.29+ $76,660.03
=
$ 49,910.74
Therefore, if Hertz uses $600,000 of five-year, 8% debt to fund the $975,000
purchase, the Adjusted Present Value (APV) of the project is $ 49,910.74.
c.
To determine the maximum price, set the APV=0 = NPV (All equity) + NPV(Loan)
0 =
-P + (1-0.40)($300,000)A
5
0.10
+ 0.2727P + $600,000 –
(1 – 0.40)(0.05)($600,000)A
5
0.08
– [$600,000/(1.08)
5
]
0 = -0.7273P +682,341.62 + 600,000 – 71,868.78 – 408,350
0.7273P = 802,122.84
P = 1,102,877.55
18.2
a.
The adjusted present value of a project equals the net present value of the project under
all-equity financing plus the net present value of any financing side effects.
In Peatco’s
case, the NPV of financing side effects equals the after-tax present value of the cash
flows resulting from the firm’s debt.
APV = NPV(All-Equity) + NPV(Financing Side Effects)
NPV(All-Equity)
NPV =
-Initial Investment + PV[(1-T
C
)(Earnings Before Taxes and Depreciation)] +
PV(CCA Tax Shield)
Assuming the company has other assets in this CCA pool,
1
0.50(
)
[
][
]
1
2,100,000 0.40 0.30
1
0.50(0.16)
[
][
]
$510,045
0.30
0.16
1
0.16
InvestmentxTaxRatexCCA
DiscountRate
PVCCATS
CCA
DiscountRate
DiscountRate
x
x
+
=
+
+
+
=
=
+
+
Answers to End-of-Chapter Problems
B-24