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Unformatted text preview: Chapter 18: Valuation and Capital Budgeting for the Levered Firm 18.1 a. The maximum price that Hertz should be willing to pay for the fleet of cars with all equity funding is the price that makes the NPV of the transaction equal to zero. NPV = Purchase Price + PV[(1 T C )(Earnings Before Taxes and Depreciation)] + PV(CCA Tax Shield) Let P equal the purchase price of the fleet. NPV = P + (10.40)($300,000)A 5 0.10 + PVCCATS 1 0.50( ) [ ][ ] 1 0.40 0.25 1 0.50(0.10) [ ][ ] 0.2727 0.25 0.10 1 0.10 InvestmentxTaxRatexCCA DiscountRate PVCCATS CCA DiscountRate DiscountRate Px x P + = + + + = = + + Set the NPV equal to zero. 0 = P + (10.40)($300,000)A 5 0.10 + 0.2727P 0.7273P= $682,341.62 P= $938,184.55 Therefore, the most that Hertz should be willing to pay for the fleet of cars with all equity funding is $938,184.55. b. The adjusted present value (APV) of a project equals the net present value of the project if it were funded completely by equity plus the net present value of any financing side effects. In Hertzs case, the NPV of financing side effects equals the aftertax present value of the cash flows resulting from the firms debt. APV = NPV(AllEquity) + NPV(Financing Side Effects) NPV(AllEquity) NPV = Purchase Price + PV[(1 T C )(Earnings Before Taxes and Depreciation)] + PV(CCATS) Hertz paid $975,000 for the fleet of cars. 1 0.50( ) [ ][ ] 1 975,000 0.40 0.25 1 0.50(0.10) [ ][ ] $265,909.09 0.25 0.10 1 0.10 InvestmentxTaxRatexCCA DiscountRate PVCCATS CCA DiscountRate DiscountRate x x + = + + + = = + + NPV = $975,000 + (1 0.4)($300,000)A 5 0.10 + 265,909.09 = 975,000 + 682,341.62+265,909.09 = $26,749.29 Answers to EndofChapter Problems B23 NPV(Financing Side Effects) The net present value of financing side effects equals the aftertax present value of cash flows resulting from the firms debt. NPV(Financing Side Effects) = Proceeds AfterTax PV(Interest Payments) PV(Principal Payments) Given a known level of debt, debt cash flows should be discounted at the pretax 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(AllEquity) + NPV(Financing Side Effects) = $26,749.29+ $76,660.03 = $ 49,910.74 Therefore, if Hertz uses $600,000 of fiveyear, 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 + (10.40)($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 allequity financing plus the net present value of any financing side effects. In Peatcos case, the NPV of financing side effects equals the aftertax present value of the cash...
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This note was uploaded on 03/17/2009 for the course ACTSC 371 taught by Professor Wood during the Fall '08 term at Waterloo.
 Fall '08
 Wood

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