Question
3. An all-equity rental car company is trying to determine whether to add cars to its fleet. The firm fully depreciates all its rental cars
3. An all-equity rental car company is trying to determine whether to add cars to its fleet. The firm fully depreciates all its rental cars over five years using the straight-line method. The new cars are expected to generate $400,000 per year in earnings before taxes and depreciation (EBTD) for five years. The company can purchase the fleet of cars for $1,000,000. The company has a 25 percent tax rate. The required return on the firms unlevered equity is 16 percent. The new fleet will not change the risk of the company.
Assume that out of the $1,000,000 cost of the fleet, $600,000 will be financed with a five-year loan from a bank. The pre-tax cost of debt is 7 percent. Interest will be paid each year but all principal will be repaid in one balloon payment at the end of the fifth year. The bank will charge the firm $10,000 in flotation fees, which will be amortized over the five-year life of the loan. Depreciation and amortization expenses are tax-deductible. What is the adjusted present value (APV) of the project? Ignore bankruptcy costs and transaction costs. Also ignore signaling, incentive, clientele, and other effects.
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