Question

Digital organics (do) has the opportunity to invest $1.06 million now (t = 0) and expects after-tax returns of $660,000 in t = 1 and $760,000 in t = 2. the project will last for two years only. the appropriate cost of capital is 13% with all-equity financing, the borrowing rate is 9%, and do will borrow $360,000 against the project. this debt must be repaid in two equal installments of $180,000 each. assume debt tax shields have a net value of $0.40 per dollar of interest paid. calculate the project’s apv. (enter your answer in dollars, not millions of dollars. do not round intermediate calculations. round your answer to the nearest whole number.)

Answer 1

The APV is found by discounting the after-tax returns at the cost of capital, adjusting for the present value of the interest tax shield, and subtracting the required debt repayments. The final result combines these calculations to reflect both the project's earnings and financing benefits.

Step-by-step explanation:

The Adjusted Present Value (APV) of Digital Organics' project is calculated by first determining the present value of the unlevered project cash flows and then adding the present value of the financing side effects, such as the tax shield from the interest paid.

First, calculate the present value of the project's cash flows using the all-equity cost of capital. Next, calculate the value of the debt tax shield. Subtract the debt repayments and add the present value of the tax shield to the unlevered net present value (NPV) to arrive at the APV.

1. Calculate the present value of the future cash flows ($660,000 for t=1 and $760,000 for t=2) using the cost of capital (13%).
2. Calculate the present value of the interest tax shield (9% of $360,000) adjusted by the net value of the tax shield ($0.40 per dollar).
3. Subtract the debt repayments ($180,000 each in t=1 and t=2).

Summing these values gives us the APV, which is the sum of the present value of the project's unlevered cash flows and the present value of the financing side effects.