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
), 7%.
NPV(Financing Side Effects)
= $850,000 – (1 – 0.38)(0.07)($850,000)A
5
0.07
– [$850,000/(1.07)
5
] = $92,705
APV
APV = NPV(All–Equity) + NPV(Financing Side Effects)
= $200,036+ $92,705
= $292,741
Therefore, if Budget uses $850,000 of five–year, 7% debt to fund the $1,100,000 purchase,
the Adjusted Present Value (APV) of the project is $292,741.
c.
To determine the maximum price, set the APV=0 = NPV (All equity) + NPV(Loan)
0 =
–P + (1–0.38)($430,000)A
5
0.09875
+ 0.26016P + $850,000
– (1 – 0.38)(0.07)($850,000)A
5
0.07
– [$850,000/(1.07)
5
]
P = $1,495,680.55
18.2
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 the joint venture’s case, the
NPV of financing side effects equals the after–tax present value of cash flows resulting from the
firms’ debt.
APV = NPV(All–Equity) + NPV(Financing Side Effects)
NPV(All–Equity)
NPV =
–Initial Investment + PV[(1 – T
C
)(Earnings Before Interest, Taxes, and Depreciation )] +
PV(CCA Tax Shield)
Since the initial investment will be fully depreciated over five years using the straight–line method,
annual depreciation expense is:
Annual depreciation = $42,000,000/5
Annual depreciation = $8,400,000
NPV =
–$42,000,000 + [(1–0.38)($4,340,000)A
30
0.145
] +
$8,400,000 x 0.38x A
5
0.145
=
–$12,934,185.97
NPV(Financing Side Effects)
The NPV of financing side effects equals the after–tax present value of cash flows resulting from the
firms’ debt.