Question

Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 5.10 percent loan with gross proceeds of $5,930,000. The interest payments on the loan will be made annually. Flotation costs are estimated to be 1.20 percent of gross proceeds and will be amortized using a straight-line schedule over the 10-year life of the loan. The company has a tax rate of 35 percent, and the loan will not increase the risk of financial distress for the company.

a. Calculate the net present value of the loan excluding flotation costs.

b. Calculate the net present value of the loan including flotation costs.

Answer 1

To calculate the net present value (NPV) of the loan excluding and including flotation costs, discount the interest payments and find the present value of the gross proceeds over the 10-year period.

Step-by-step explanation:

To calculate the net present value (NPV) of the loan excluding flotation costs, we need to discount the annual interest payments using the given interest rate and find the present value of the gross proceeds. Assuming a 10% discount rate, the NPV can be calculated as follows:

NPV = (Interest Payment / (1 + Discount Rate) ^ Year) + (Gross Proceeds / (1 + Discount Rate) ^ Year)

For each year, the interest payment can be calculated as the gross proceeds multiplied by the interest rate, and the discount rate is 1 plus the interest rate. By summing up the present values of the interest payments and the gross proceeds over the 10-year period, we can find the NPV excluding flotation costs.

To calculate the NPV including flotation costs, we need to consider the amortization of the flotation costs over the 10-year life of the loan. The annual amortization amount can be calculated as the flotation costs divided by 10. For each year, the interest payment should be reduced by the amortization amount before discounting it.

By following these calculations, we can find the NPV of the loan both excluding and including flotation costs.

Answer 2

The net present value (NPV) of the loan excluding flotation costs is $8,530,016.52

Step-by-step explanation:

In order to calculate the net present value (NPV) of the loan excluding flotation costs, we need to calculate the present value (PV) of the interest payments and the repayment of the loan. We can use the formula PV = C/(1+r)^n, where C represents the cash flow, r represents the discount rate, and n represents the number of periods.

For the interest payments, the cash flow is $5,930,000 * 5.10% = $302,430 and the discount rate is 5.10%. Since the interest payments are made annually for 10 years, n is equal to 10. Plugging these values into the formula, we calculate the present value of the interest payments to be $2,600,016.52.

For the repayment of the loan, the cash flow is the initial loan amount of $5,930,000 and the discount rate and number of periods remain the same. Plugging these values into the formula, we calculate the present value of the loan repayment to be $5,930,000.

Next, we add the present values of the interest payments and the loan repayment to find the NPV excluding flotation costs:

NPV excluding flotation costs = Present value of interest payments + Present value of loan repayment = $2,600,016.52 + $5,930,000 = $8,530,016.52