EBK CORPORATE FINANCE
4th Edition
ISBN: 9780134202785
Author: DeMarzo
Publisher: VST
expand_more
expand_more
format_list_bulleted
Concept explainers
Videos
Textbook Question
Chapter 18, Problem 16P
You are evaluating a project that requires an investment of $90 today and provides a single cash flow of $115 for sure one year from now. You decide to use 100% debt financing, that is, you will borrow $90. The risk-free rate is 5% and the tax rate is 40%. Assume that the investment is fully
- a. Calculate the
NPV of this investment opportunity using the APV method. - b. Using your answer to part a, calculate the WACC of the project.
- c. Verify that you get the same answer using the WACC method to calculate NPV.
- d. Finally, show that flow-to-equity also correctly gives the NPV of this investment opportunity.
Expert Solution & Answer
Trending nowThis is a popular solution!
Students have asked these similar questions
You are evaluating a project that requires an investment of
$97
today and garantees a single cash flow of
$115
one year from now. You decide to use
100%
debt financing, that is, you will borrow
$97.
The risk-free rate is
6%
and the tax rate is
30%.
Assume that the investment is fully depreciated at the end of the year, so without leverage you would owe
taxes on the difference between the project cash flow and the investment, that is,
$18.
a. Calculate the NPV of this investment opportunity using the APV method.
b. Using your answer to part
(a),
calculate the WACC of the project.
c. Verify that you get the same answer using the WACC method to calculate NPV.
d. Finally, show that flow-to-equity method also correctly gives the NPV of this investment opportunity.
You are evaluating a project that requires an investment of $102 today and garantees a single cash flow of $127 one year from now. You decide to use 100% debt financing, that is, you will borrow $102. The risk-free rate is 5% and the tax rate is 39%. Assume that the investment is fully depreciated at the end of the year, so without leverage you would owe taxes on the difference between the project cash flow and the investment, that is, $25.
Calculate the NPV of this investment opportunity using the APV method. (Round to two decimalplaces.)
Using your answer to part (1), calculate the WACC of the project. (Round to two decimalplaces.)
Verify that you get the same answer using the WACC method to calculate NPV. (Round to two decimalplaces.)
Finally, show that flow-to-equity method also correctly gives the NPV of this investment opportunity. (Round to two decimalplaces.)
You can make an investment that will immediately cost $52,000. If you make the investment, your after-tax operating
profit will be $13,000 per year for five years. After the five years, the profit will be zero, and the scrap value also will be
zero. You will finance the investment with internally generated funds and receive the profit at the end of each year.
The net present value equation for this investment is: NPV=$|
(Carefully enter your answer as an algebraic expression, using the proper notation in the proper format. Do not use the
letter x to denote the multiplication sign.)
Chapter 18 Solutions
EBK CORPORATE FINANCE
Ch. 18.1 - What are the three methods we can use to include...Ch. 18.1 - Prob. 2CCCh. 18.2 - Prob. 1CCCh. 18.2 - Prob. 2CCCh. 18.3 - Prob. 1CCCh. 18.3 - Prob. 2CCCh. 18.4 - Prob. 1CCCh. 18.4 - Prob. 2CCCh. 18.5 - How do we estimate a projects unlevered cost of...Ch. 18.5 - What is the incremental debt associated with a...
Ch. 18.6 - Prob. 1CCCh. 18.6 - Prob. 2CCCh. 18.7 - How do we deal with issuance costs and security...Ch. 18.7 - Prob. 2CCCh. 18.8 - When a firm has pre-determined tax shields, how do...Ch. 18.8 - Prob. 2CCCh. 18 - Prob. 1PCh. 18 - Prob. 2PCh. 18 - In 2015, Intel Corporation had a market...Ch. 18 - Prob. 4PCh. 18 - Suppose Goodyear Tire and Rubber Company is...Ch. 18 - Suppose Alcatel-Lucent has an equity cost of...Ch. 18 - Acort Industries has 10 million shares outstanding...Ch. 18 - Prob. 8PCh. 18 - Prob. 9PCh. 18 - Consider Alcatel-Lucents project in Problem 6. a....Ch. 18 - Consider Alcatel-Lucents project in Problem 6. a....Ch. 18 - In year 1, AMC will earn 2000 before interest and...Ch. 18 - Prokter and Gramble (PKGR) has historically...Ch. 18 - Amarindo, Inc. (AMR), is a newly public firm with...Ch. 18 - Remex (RMX) currently has no debt in its capital...Ch. 18 - You are evaluating a project that requires an...Ch. 18 - Prob. 17PCh. 18 - You are on your way to an important budget...Ch. 18 - Your firm is considering building a 600 million...Ch. 18 - Prob. 20PCh. 18 - DFS Corporation is currently an all-equity firm,...Ch. 18 - Prob. 22PCh. 18 - Prob. 23PCh. 18 - Prob. 24PCh. 18 - XL Sports is expected to generate free cash flows...Ch. 18 - Propel Corporation plans to make a 50 million...Ch. 18 - Gartner Systems has no debt and an equity cost of...Ch. 18 - Revtek, Inc., has an equity cost of capital of 12%...
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Your division is considering two investment projects, each of which requires an up-front expenditure of 25 million. You estimate that the cost of capital is 10% and that the investments will produce the following after-tax cash flows (in millions of dollars): a. What is the regular payback period for each of the projects? b. What is the discounted payback period for each of the projects? c. If the two projects are independent and the cost of capital is 10%, which project or projects should the firm undertake? d. If the two projects are mutually exclusive and the cost of capital is 5%, which project should the firm undertake? e. If the two projects are mutually exclusive and the cost of capital is 15%, which project should the firm undertake? f. What is the crossover rate? g. If the cost of capital is 10%, what is the modified IRR (MIRR) of each project?arrow_forwardThe Rodriguez Company is considering an average-risk investment in a mineral water spring project that has an initial after-tax cost of 170,000. The project will produce 1,000 cases of mineral water per year indefinitely, starting at Year 1. The Year-1 sales price will be 138 per case, and the Year-1 cost per case will be 105. The firm is taxed at a rate of 25%. Both prices and costs are expected to rise after Year 1 at a rate of 6% per year due to inflation. The firm uses only equity, and it has a cost of capital of 15%. Assume that cash flows consist only of after-tax profits because the spring has an indefinite life and will not be depreciated. a. What is the present value of future cash flows? (Hint: The project is a growing perpetuity, so you must use the constant growth formula to find its NPV.) What is the NPV? b. Suppose that the company had forgotten to include future inflation. What would they have incorrectly calculated as the projects NPV?arrow_forwardMason, Inc., is considering the purchase of a patent that has a cost of $85000 and an estimated revenue producing lite of 4 years. Mason has a required rate of return that is 12% and a cost of capital of 11%. The patent is expected to generate the following amounts of annual income and cash flows: A. What is the NPV of the investment? B. What happens if the required rate of return increases?arrow_forward
- Buena Vision Clinic is considering an investment that requires an outlay of 600,000 and promises a net cash inflow one year from now of 810,000. Assume the cost of capital is 10 percent. Required: 1. Break the 810,000 future cash inflow into three components: a. The return of the original investment b. The cost of capital c. The profit earned on the investment 2. Now, compute the present value of the profit earned on the investment. 3. Compute the NPV of the investment. Compare this with the present value of the profit computed in Requirement 2. What does this tell you about the meaning of NPV?arrow_forwardTropical Sweets is considering a project that will cost $70 million and will generate expected cash flows of $30 million per year for 3 years. The cost of capital for this type of project is 10%, and the risk-free rate is 6%. After discussions with the marketing department, you learn that there is a 30% chance of high demand with associated future cash flows of $45 million per year. There is also a 40% chance of average demand with cash flows of $30 million per year as well as a 30% chance of low demand with cash flows of only $15 million per year. What is the expected NPV?arrow_forwardYour boss asked you to evaluate a project with an infinite life. Sales and costs project to $1,000 and $500 per year, respectively. (Assume sales and costs occur at the end of the year [i.e., profit of $500 at the end of year one]). There is no depreciation and the tax rate is 21 percent. The real required rate of return is 10 percent. The inflation rate is 4 percent and is expected to be 4 percent forever. Sales and costs will increase at the rate of inflation. If the project costs $3,000, what is the NPV? Multiple Choice $950.00 $1,629.62 $365.38 $472.22arrow_forward
- You are evaluating a project which requires Rs.100000 investments and produce Rs.20000 cash flow for 6 years. The cost of equity for all equity firm is 15%. Find the NPV of the project and if NPV is negative, then find at what rate of debt (available at 10%) does this project NPV turn positive? Also, find the cost of capital at that debt level. Assume tax rate to be 25%.arrow_forwardYour firm is considering financing a project that costs $1,000,000 by raising $500,000 in equity and $500,000 in debt with a 7% interest rate for 8 years. The NPV of the unlevered project would be -$50,000. Assume that the tax rate for your firm stays at 24%. What is the value of the tax subsidy to debt in this case? Is this value large enough to take the levered project?arrow_forwardConsider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.68 million per year for 10 years. The opportunity cost of capital is 11.15%, which reflects the project's business risk. a. Suppose the project is financed with $4 million of debt and $6 million of equity. The interest rate is 7.15% and the marginal tax rate is 21%. An equal amount of the debt will be repaid in each year of the project's life. Calculate APV. (Enter your answer in dollars, not millions of dollars. Do not round Intermediate calculations. Round your answer to the nearest whole number.) X Answer is complete but not entirely correct. Adjusted present value S 120,980 x b. If the firm Incurs issue costs of $610,000 to raise the $6 million of required equity, what will be the APV? (Enter your answer in dollars, not millions of dollars. Do not round Intermediate calculations. Round your answer to the nearest whole number. Negative amount shoud be…arrow_forward
- Muscat Metal is evaluating a project that requires an investment of $150 million today and provides a single cash flow of $180 million for sure one year from now. Muscat Metal decides to use 100% debt financing for this investment. The risk-free rate is 5% and Muscat's corporate tax rate is 21%. Assume that the investment is fully depreciated at the end of the year. The NPV of this project using the APV method is closest to: a. $71 million. b. $10 million c. $17 million. d. $42 millionarrow_forwardConsider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.64 million per year for 10 years. The opportunity cost of capital is 10.35%, which reflects the project's business risk. a. Suppose the project is financed with $4 million of debt and $6 million of equity. The interest rate is 6.55% and the marginal tax rate is 21%. An equal amount of the debt will be repaid in each year of the project's life. Calculate APV. Note: Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations. Round your answer to the nearest whole number. b. If the firm incurs issue costs of $650,000 to raise the $6 million of required equity, what will be the APV? Note: Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations. Round your answer to the nearest whole number. Negative amount should be indicated by a minus sign. a. Adjusted present value b. Adjusted present…arrow_forwardConsider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.71 million per year for 10 years. The opportunity cost of capital is 11.45%, which reflects the project’s business risk. a. Suppose the project is financed with $5 million of debt and $5 million of equity. The interest rate is 7.55% and the marginal tax rate is 21%. An equal amount of the debt will be repaid in each year of the project's life.Calculate APVarrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage Learning
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
Principles of Accounting Volume 2AccountingISBN:9781947172609Author:OpenStaxPublisher:OpenStax College
Cornerstones of Cost Management (Cornerstones Ser...
Accounting
ISBN:9781305970663
Author:Don R. Hansen, Maryanne M. Mowen
Publisher:Cengage Learning
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Principles of Accounting Volume 2
Accounting
ISBN:9781947172609
Author:OpenStax
Publisher:OpenStax College
Working capital explained; Author: The Finance Storyteller;https://www.youtube.com/watch?v=XvHAlui-Bno;License: Standard Youtube License