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1. An unlevered firm is considering a project that costs $10,000,000. The $10,000,000 cost will be fully depreciated over its five-year life using straight-line method.
1. An unlevered firm is considering a project that costs $10,000,000. The $10,000,000 cost will be fully depreciated over its five-year life using straight-line method. The project is expected to generate earnings before taxes and depreciation (EBTD) of $4,000,000 per year for five years. The firm can obtain a five-year loan to finance the $10,000,000 project from a financial institution. Assume that the firm will borrow $10,000,000. The financial institution charges before-tax interest rate (cost of debt) of 8 percent for the loan. It also charges the firm $100,000 in flotation fees, which will be amortized over the five-year life of the loan. Interests will be paid every year but all principal will be repaid in one balloon payment at the end of the fifth year. Depreciation and amortization expenses are tax-deductible. If the company financed the project entirely with equity, the firm's cost of capital would be 16 percent. The corporate tax rate is 25 percent. Assume the project has the same risk as the firm overall. Find the adjusted present value (APV) of the project. Should the firm accept the project
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