The processing plant Gaylord is considering costs $2.5 million, whichcan be depreciated on a straight-line basis over 10 years. The plant is expected to have zero salvage value after ten years. Gaylord uses the T-Bill rate to calculate the present value of the depreciation tax shield. Assume that Gaylord has sufficient income from its other operations to take full advantage of any losses for tax purposes.Gaylord projects that it will be able to sell 500,000 pounds of processed product per year over the 10-year life of the project. It anticipates receiving a real price or $3.05 per pound. Variable costs are estimated at $1.95 per pound (in real terms), while annual real fixed (tax deductible) operating costs are estimated to be $150,000.

(c)(8points) Calculate the NPV of the proposed investment project as an all-equity investment.

Now supposethat Gaylord is given the opportunity to finance the full $2.5 million investment with municipal bonds. In the absence of the interest rate subsidy, Gaylord is told that the nominal interest on its debt would be 6.5% annually, but with the subsidy the firm will only have to pay a nominal annual interest of 4.5%. The bonds would have a maturity of 10 years, at which time they would be redeemed in full. Toissue the debt, however, Gaylord would need to pay flotation costs equal to 1% of the amount raised. These costs, which are funded from retained earnings, can be amortized on a straight-line basis over the life of the loan.

(d)(6points) Calculate the present value of the financial side effects using the nominal bond return to discount future cash flows, and hence obtain the APV of the project.