CHAPTER 19

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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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