Digital Organics (DO) has the opportunity to invest $1 million now ( t = 0) and expects after-tax returns of $600,000 in t = 1 and $700,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 12% with all-equity financing, the borrowing rate is 8%, and DO will borrow $300,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of $.30 per dollar of interest paid. Calculate the project’s APV using the procedure followed in Table 20.2 .

TABLE 20.2

APV valuation of Rio Corporation ($ millions).

	Latest
	year	Forecast
	0	1	2	3	4	5	6	7
Free cash flow	2.5	3.5	3.2	3.4	5.9	6.1	6.0	6.8
PV Free cash flow, years 1-6	19.7
PV Horizon value	64.6			(Horizon value in year 6)			113.4
Base-Case PV of company	84.3
Debt	51.0	50.0	49.0	48.0	47.0	46.0	45.0
Interest		3.06	3.00	2.94	2.88	2.82	2.76
Interest tax shield		1.07	1.05	1.03	1.01	0.99	0.97
PV Interest tax shields	5.0
APV	89.3
Tax rate, %	35.0
Opportunity cost of capital, %	9.84
WACC, % (to discount horizon value to year 6)	9.0
Long-term growth forecast, %	3.0
Interest rate, % (years 1-6)	6.0
After-tax debt service		2.99	2.95	2.91	2.87	2.83	2.79