Question
Pecotts, Inc. is a firm without debt. The firm is considering an investment of $1.32 million with four-year life. The investment will be depreciated according
Pecotts, Inc. is a firm without debt. The firm is considering an investment of $1.32 million with four-year life. The investment will be depreciated according to the straight-line method over its life. The project is expected to generate earnings before taxes and depreciation of $470,000 per year for four years. The investment will not change the risk level of the firm.
Pecotts can obtain a four-year, 9.5 percent loan to finance the project from a local bank. All principal will be repaid in one balloon payment at the end of the fourth year. The bank will charge the firm $45,000 in flotation fees, which will be amortized over the four-year life of the loan. If the company financed the project entirely with equity, the firms cost of capital would be 14 percent. The corporate tax rate is 25 percent.
Using the APV method, determine whether the company should undertake the project.
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