You work for a large manufacturing company in the Midwest. The company is thinking about opening a new factory, and your job is to evaluate the investment. Currently, the firm has a debt-to-equity ratio of 1. Its cost of debt is 5%, and its cost of equity is 15%. What is the cost of its assets? The new factory will require an investment of $10 million today and another $10 million in one year. On the plus side, the new factory will generate extra free cash flows of $1.8 million starting in one year, and continuing every year forever. What is the NPV of this projects operations if the project used all equity financing? To finance the new factory, you plan to use debt. In particular, you will raise $5 million in debt today, and an additional $5 million in one year. Further, you will never pay off the principal of the debt, so that after year 1 you keep the $10 million in debt on your balance sheet forever. If the interest rate on the debt is 4% and your tax rate is 30%, what are the interest expense and interest tax shields for year 1? Year 2? Every year after year 2?

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