Question

Gemini, Inc. , an all-equity firm, is considering an investment of $1. 64 million that will be depreciated according to the straight-line method over its four-year life. The project is expected to generate earnings before taxes and depreciation of $604,000 per year for four years. The investment will not change the risk level of the firm. The company can obtain a four-year, 8. 5 percent loan to finance the project from a local bank. All principal will be repaid in one balloon payment at the end of the fourth year. The bank will charge the firm $54,000 in flotation fees, which will be amortized over the four-year life of the loan. If the company financed the project entirely with equity, the firm’s cost of capital would be 14 percent. The corporate tax rate is 35 percent.

Using the adjusted present value method, calculate the APV of the project. (Enter your answer in dollars, not millions of dollars, e. G. , 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e. G. , 32. 16. )

APV $

Answer 1

To calculate the adjusted present value (APV) of the project, we need to calculate the present value of the tax shield from the loan, as well as the present value of the project's cash flows.

First, let's calculate the present value of the tax shield:

PV(Tax Shield) = TC x D x rD x (1 - (1 + rD)^-n) / rD
PV(Tax Shield) = 0.35 x $1,640,000 x 0.085 x (1 - (1 + 0.085)^-4) / 0.085
PV(Tax Shield) = $397,113.18

Next, let's calculate the present value of the project's cash flows:

PV(Cash Flows) = CF x (1 - TC) x (1 - (1 + rD)^-n) / rD
PV(Cash Flows) = $604,000 x (1 - 0.35) x (1 - (1 + 0.085)^-4) / 0.085
PV(Cash Flows) = $1,715,842.04

Finally, let's add the present value of the tax shield to the present value of the cash flows and subtract the flotation costs:

APV = PV(Cash Flows) + PV(Tax Shield) - Flotation Costs
APV = $1,715,842.04 + $397,113.18 - $54,000
APV = $2,058,955.22

Therefore, the APV of the project is $2,058,955.22.