Digital Organics (DO) has the opportunity to invest $1.07 million now (t = 0) an
ID: 2755153 • Letter: D
Question
Digital Organics (DO) has the opportunity to invest $1.07 million now (t = 0) and expects after-tax returns of $670,000 in t = 1 and $770,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 14% with all-equity financing, the borrowing rate is 10%, and DO will borrow $370,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of $0.25 per dollar of interest paid. Calculate the project’s APV. (Do not round intermediate calculations. Rounddown your answer to the nearest whole dollar.) PLEASE SHOW ALL OF THE STEPS THANK YOU
Explanation / Answer
Project’s APV = Net present value of cash flow + Present value of Tax Shield(or financing)
= $109720 + (10% * $370000 * $0.25)
= $109720 + $9250
= $118970
Note:- Net Present Value: by cost of equity = 14%
year cash flow PVF(14% , 2 years) Present Value
0 -1070000 1 -1070000
1 670000 0.877 587590
2 770000 0.769 592130
Net present value = (587590 + 592130) - 1070000
= 1179720 - 1070000
= $109720