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Assignment4 Solution

# Assignment4 Solution - Assignment 4 Solutions Problem 1(a...

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Assignment 4 Solutions. Problem 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 + (1-0.40)(\$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 + (1-0.40)(\$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 Hertz’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)

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NPV(All-Equity) 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 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