DEF Corporation is interested in undertaking an investment opportunity that requires the purchase of a capital asset in the amount of $3,000,000 initially. The investment opportunity is expected to last for five years. DEF Corporation can choose to finance the initial amount with 100% equity. At this level of financial leverage, the cost of equity is 8%, and the investment opportunity is expected to generate the following at the end of year one: Sales = $7,000,000 Cost of goods sold = $3,000,000 Other operating expenses = $1,000,000 Depreciation = $500,000 No working capital and no additional capital expenditures are required. All of the above amounts are expected to remain the same throughout the investment period. Instead of financing the investment opportunity with 100% equity, DEF Corporation has the option to raise $900.000 of debt and $2,100,000 of equity. The pre-tax cost of debt will be 4% per year, and this amount is not expected to change throughout the investment period. The applicable corporate tax rate is 25%. Hint: The answers for parts a, b, and c may not be the same. a. Calculate the adjusted present value (APV) of the investment opportunity, assuming that DEF Corporation chooses to go with the levered financing option. Show your work. ? ENG IN 6:42 PM 2020-04-19 No working capital and no additional capital expenditures are required. All of the above amounts are expected to remain the same throughout the investment period. Instead of financing the investment opportunity with 100% equity, DEF Corporation has the option to raise $900.000 of debt and $2,100,000 of equity. The pre-tax cost of debt will be 4% per year, and this amount is not expected to change throughout the investment period. The applicable corporate tax rate is 25%. Hint: The answers for parts a, b, and c may not be the same. a. Calculate the adjusted present value (APV) of the investment opportunity, assuming that DEF Corporation chooses to go with the levered financing option. Show your work. b. Calculate the net present value of the investment opportunity using the flow to equity (FTE) approach, assuming that DEF Corporation chooses to go with the levered financing option. Show your work c. Calculate the net present value of the investment opportunity using the weighted average cost of capital (WACC) approach, assuming that DEF Corporation chooses to go with the levered financing option. Show your work
