The nation\'s largest chicken-wing producer, Consolidated Eggleston Inc, (CEI),
ID: 2794361 • Letter: T
Question
The nation's largest chicken-wing producer, Consolidated Eggleston Inc, (CEI), plans to expand its capacity by building more chicken coops. The expansion project will require an initial out lay of $10 million and will generate an unlevered cash flow of $1 million in perpetuity. CEI uses twice as much equity as debt to finance its operations. Its pre-tax cost of debt is 6%, and its cost of equity is 10%. The marginal corporate tax rate is 30%. Calculate the value of this investment opportunity using the APV method.
Explanation / Answer
Cost of equity=10%
NPV=-10+1/10%=0
Interest Tax shield=Debt*tax rate*interest cost/(1-1/(1+interest cost))=1/3*10*30%*6%/(1-1/1.06)=0.06/(1-1/1.06)=1.06 million
So, APV=0+1.06=1.06 million