he Sretaw Regor (SR) Corporation is considering a new 5-year project. Since this project is very different from SR's current operations, the adjusted present value will be used to value the project.

The project requires an initial investment of $250,000 in new assets, which will be depreciated straight-line to 0 over the project's 5-year life. These assets will be worthless in five years, i.e., they will not be resold. Each year for five years, the project is expected to generate pre-tax revenues of $450,000 and to require pre-tax costs of $350,000. The entire project's initial investment will be financed through a 5-year bank loan with an annual rate of 8%. The principal on the loan will be repaid in equal installments (i.e., each year, the company pays principal, and pays the interest on the outstanding loan). It is estimated that the pre-tax costs (payable at time zero) of negotiating the loan will be 7% of the amount borrowed and these costs cannot be amortized.

The project's risk is very similar to the risk of Ruomlig Divad (RD) Inc.'s assets. This firm is currently financed by 100,000 shares worth $20 each, and $1,000,000 worth of debt. The beta of RD's stock is 1.7, and the company borrows at a rate of 7%.

The riskfree rate in the economy is 5%, and the expected excess return on the market is 6%. The current corporate tax rate is 35% (assume that it applies to both SR and RD). Ignore personal taxes.

a) What is the appropriate discount rate for the project?

b) What is the NPV of the project before financing considerations?

c) What is the APV of the project?

d) Now consider an alternative financing. The entire project still will be financed through a 5-year bank loan but with government-subsidized annual rate (R_D^{sub}) of 7.5% (market rate for such loans is still 8%), and with principal repaid in a lump sum at the end of the fifth year. However, such loan requires floatation costs (payable at time zero) of 15% of the amount borrowed. In this case the floatation costs can be amortized over the project's 5 year life.

Would you prefer this loan to the previous one?