Digital Organics (DO) has the opportunity to invest $1.03 million now ( t = 0) a
ID: 2768026 • Letter: D
Question
Digital Organics (DO) has the opportunity to invest $1.03 million now (t = 0) and expects after-tax returns of $630,000 in t = 1 and $730,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 11% with all-equity financing, the borrowing rate is 7%, and DO will borrow $330,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of $0.20 per dollar of interest paid. Calculate the project’s APV. (Do not round intermediate calculations. Rounddown your answer to the nearest whole dollar.)
Adjusted present value $
Explanation / Answer
Base case NPV = -Initial outlay+ Present value of after tax future cash inflows
year
cash flow
After tax cash flows
PV factor @11%
PV of cash flow
0
-1,030,000
-1,030,000
1
-1030000
1
630000
504000
0.900900901
454054.0541
2
730000
584000
0.811622433
473987.501
NPV
-101958.4449
APV = Base case NPV + PV of tax shield due to interest paid
= -101958.45 + PV when i = 7%, n= 2, pmt = (0.2*330,000*7%) = 4620
= -101958.45 + 8353.04
= -93605.40
therefore adjusted present value is -93605.40
year
cash flow
After tax cash flows
PV factor @11%
PV of cash flow
0
-1,030,000
-1,030,000
1
-1030000
1
630000
504000
0.900900901
454054.0541
2
730000
584000
0.811622433
473987.501
NPV
-101958.4449