Question

Digital Organics (DO) has the opportunity to invest $1.02 million now (t = 0) and expects after-tax returns of $620,000 in t = 1 and $720,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 14% with all-equity financing, the borrowing rate is 10%, and DO will borrow $320,000 against the project. This debt must be repaid in two equal installments of $160,000 each. Assume debt tax shields have a net value of $0.25 per dollar of interest paid.
Calculate the project’s APV.

Answer 1

Answer:

The APV of a project will be "$88,958.52".

Explanation:

To calculate the APV (Adjusted Present Value):

NPV of a Equity Financing = $[-Investment+(\frac{Aftertax \ Returns \ year1}{(1+Rate)})+(\frac{Aftertax \ Return \ year2}{(1+Rate)^2})]$

On putting the values in the above formula, we get

= $[-1020000+(\frac{620000}{1+14 \ percent})+(\frac{720000}{1+14 \ percent^2})]$

= $[-1020000+543859.65+554016.62]$

= $$77876.27$

Present value:

When $320000 is funded with department to be reimbursed in two installments of I, we provide

⇒ $320000 = $\frac{I}{1.10} +\frac{I}{1.10^2}$

⇒                $I$= $$184380.95$

During first year of a installment,

[320000×0.10] = $32000 is of concern interest as well as the remaining

$152380.95 ($184380.95-$32000) seems to be of principal repayment which leaves $167619.05 ($320000-$152380.95) as a debt for the next year.

Now,

APV = $[NPV \ of \ Financial+Total \ Tax \ Shield]$

On putting the values in the above formula, we get

⇒       = $[77878.27+11082.25]$

⇒       = $$88958.52$