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Purchase price $200 Mil. Salvage at the end of year five $50 mil. Firm borrows $200 million to fully finance the deal The borrowing terms are level annual principal payments of $40 mil apiece for five years Borrowing rate on loan is 6% Total interest

Purchase price $200 Mil. Salvage at the end of year five $50 mil. Firm borrows $200 million to fully finance the deal The borrowing terms are level annual principal payments of $40 mil apiece for five years Borrowing rate on loan is 6% Total interest

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Purchase price $200 Mil. Salvage at the end of year five $50 mil. Firm borrows $200 million to fully finance the deal The borrowing terms are level annual principal payments of $40 mil apiece for five years Borrowing rate on loan is 6%. Total interest expense over the life of the loan is $30 mil. Discount rate 5% (.952, .907, .864, .823, and .783) Cash flows years one through three $45 mil apiece; Cash flows years four and five $55 mil apiece. Year Factor 1 2 3 4 5 Nominal cash flow .952 .907 .864 $45 mil $45 mil $45 mil $55 mil $55 mil Salv. Totals $50 mil $285 mil .823 .783 .783 NPV $42.84 mil $40.81 mil $38.88mil $45.26mil $43.06mil $39.15 mil $250.00 mil Question 1- Based on the NPV of the cash flows, is this a good project to fund? Economically viable? Yes because NPV of $250 mil. less interest expense of $30 mil. exceeds project cost of $200 mil. Question 2 - on a nominal (or accounting basis) is this project profitable? Does the project provide sufficient nominal cash flow to cover the cost of installation and the payback of principal and interest? Yes. This project has projected nominal cash flow of $285 mil. The Bank loans will be paid back in nominal dollars, principal and interest. The total cost of the project is $230 million ($200 mil. in loans and $30 million interest expense)
Transcribed Image Text:Purchase price $200 Mil. Salvage at the end of year five $50 mil. Firm borrows $200 million to fully finance the deal The borrowing terms are level annual principal payments of $40 mil apiece for five years Borrowing rate on loan is 6%. Total interest expense over the life of the loan is $30 mil. Discount rate 5% (.952, .907, .864, .823, and .783) Cash flows years one through three $45 mil apiece; Cash flows years four and five $55 mil apiece. Year Factor 1 2 3 4 5 Nominal cash flow .952 .907 .864 $45 mil $45 mil $45 mil $55 mil $55 mil Salv. Totals $50 mil $285 mil .823 .783 .783 NPV $42.84 mil $40.81 mil $38.88mil $45.26mil $43.06mil $39.15 mil $250.00 mil Question 1- Based on the NPV of the cash flows, is this a good project to fund? Economically viable? Yes because NPV of $250 mil. less interest expense of $30 mil. exceeds project cost of $200 mil. Question 2 - on a nominal (or accounting basis) is this project profitable? Does the project provide sufficient nominal cash flow to cover the cost of installation and the payback of principal and interest? Yes. This project has projected nominal cash flow of $285 mil. The Bank loans will be paid back in nominal dollars, principal and interest. The total cost of the project is $230 million ($200 mil. in loans and $30 million interest expense)
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