Question
Truck-Or-Treat specializes in leasing trucks to delivery companies. It is considering adding 25 more trucks to its available stock. Doing so will not change the
Truck-Or-Treat specializes in leasing trucks to delivery companies. It is considering adding 25 more trucks to its available stock. Doing so will not change the risk of the company's business. The trucks depreciate over four years under the straight-line depreciation method, all the way to zero. Truck-Or-Treat believes that these newly added trucks would be able to bring the company $250,000 in annual earnings before taxes and depreciation (i.e., sales revenue minus costs of goods sold) for four years. The company is unlevered. It is in 22 percent tax rate bracket. The required annual rate of return on Truck-Or-Treat's unlevered equity is 11 percent. The risk-free rate, e.g., the Treasury bill rate, is 6 percent per year. |
a. | Calculate the maximum price that Truck-or-Treat should be willing to pay for the purchase of the new trucks if it remains an unlevered company. (In other words, what should be the "initial investment" of this unlevered truck project such that the project's NPV equals $0?) (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) |
b. | Now, forget about what you've calculated in part (a). Let's assume that Truck-Or-Treat can buy the trucks for $620,000. In addition, let's assume that it can issue $360,000 worth of four-year debt to partially pay for this project's initial investment, and that the financing will be done at the risk-free rate equal to 6 percent per year. The debt matures at the end of the fourth year at which point the principal will be repaid in one balloon payment. Calculate the APV of the project, i.e., the NPV of this financed project adjusted for the financing side effects. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) |
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