Unformatted text preview: e tax $79.3 T ax 27.8 Net income $51.5 Value of equity = $51.5/0.15 = $343.3
Value of firm = $343.3 + $75.6 + $208.6 = $627.5 7. The problem here is that issue costs are a onetime expenditure, while adjusting the
WACC implies a correction every year. The only way to account for issue costs in project
evaluation is to use the APV formulation and adjust directly by subtracting the issue costs
from the base case NPV. 8. a. Base case NPV = 1,000 + (600/1.12) + (700/1.122) = $93.75 or $93,750 D ebt Outstanding at Interest
PV
Y ear
Start Of Year
Interest
Tax Shield
(Tax Shield)
1
300
24
7.20
6.67
2
150
12
3.60
3.09 APV = 93.75 + 6.67 + 3.09 = 103.5 or $103,500
9. [$100,000 ´ (1 0.35)] + [$100,000 ´ (1 0.35) ´ (Annuity Factor5/9 (1 – 0.35)%)] = $65,000 + $274,925 = $339,925 10. a. Basecase NPV = $1,000,000 + ($85,000/0.10) = $150,000 PV(tax shields) = 0.35 ´ $400,000 = $140,000 APV = $150,000 + $140,000 = $10,000
b. PV(tax shields, approximate) = (0.35 ´ 0.07 ´ $400,000)/0.10 = $98,000 APV = $150,000 + $98,000 = $52,000 PV(tax shields, exact) = $98,000 ´ (1.10/1.07) = $100,748 APV = $150,000 + $100,748 = $49,252 The present value of the tax shield is higher when the debt is fixed and therefore the tax
shield is certain. When borrowing a constant proportion of the market value of the project,
the interest tax shields are as uncertain as the value of the project, and therefore must be
discounted at the project’s opportunity cost of capital. 11. The immediate source of funds (i.e., both the proportion borrowed and the expected return
on the stocks sold) is irrelevant. The project would not be any more valuable if the
university sold stocks offering a lower return. If borrowing is a zeroNPV activity for a tax
exempt university, then basecase NPV equals APV, and the adjusted cost of capital r*
equals the opportunity cost of capital with allequity financing. Here, basecase NPV is
negative; the university should not invest. 12. r* is the aftertax adjusted weighted average...
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 Fall '04
 JAMESBRIDGEMAN
 Math, Debt, Trigraph, APV, tax shields, issue costs

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