Question

Digital Organics (DO) has the opportunity to invest $1.02 million now (t = 0) and expects after-tax returns of $620,000 in t = 1 and $720,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 14% with all-equity financing, the borrowing rate is 10%, and DO will borrow $320,000 against the project. This debt must be repaid in two equal installments of $160,000 each. Assume debt tax shields have a net value of $0.25 per dollar of interest paid.

Calculate the project’s APV.

Answer 1

The APV of a project will be "$88,958.52".

Step-by-step explanation:

To calculate the APV (Adjusted Present Value):

NPV of a Equity Financing =
`[-Investment+((Aftertax \ Returns \ year1)/((1+Rate)))+((Aftertax \ Return \ year2)/((1+Rate)^2))]`

On putting the values in the above formula, we get

=
`[-1020000+((620000)/(1+14 \ percent))+((720000)/(1+14 \ percent^2))]`

=
`[-1020000+543859.65+554016.62]`

= $
`77876.27`

Present value:

When $320000 is funded with department to be reimbursed in two installments of I, we provide

⇒ $320000 =
`(I)/(1.10) +(I)/(1.10^2)`

⇒
`I`= $
`184380.95`

During first year of a installment,

[320000×0.10] = $32000 is of concern interest as well as the remaining

$152380.95 ($184380.95-$32000) seems to be of principal repayment which leaves $167619.05 ($320000-$152380.95) as a debt for the next year.

Now,

APV =
`[NPV \ of \ Financial+Total \ Tax \ Shield]`

On putting the values in the above formula, we get

⇒ =
`[77878.27+11082.25]`

⇒ = $
`88958.52`