Problem 19-16 APV Digital Organics (DO) has the opportunity to invest $1.09 mill

Question

Problem 19-16 APV Digital Organics (DO) has the opportunity to invest $1.09 million now (t 0) and expects after-tax returns of $690,000 in t 1 and $790,000 in t 2. The project will last for two years only. The appropriate cost of capital is 10% with all-equity financing, the borrowing rate is 6%, and DO will borrow $390,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of 0.35 per dollar of interest paid. Calculate the project's APV. (Do not round intermediate calculations. Rounddown your awe to the nearest whole dolar-) Adjusted present value

Explanation / Answer

1) Unlevered value of operations = 690000/1.1+790000/1.1^2-1090000 = $ 1,90,165 2) PV of tax shield on interest: The annual instalments = 390000*0.06*1.06^2/(1.06^2-1) = $ 2,12,720 Interest in the 1st year = 390000*6% = $     23,400 Interest in the 2nd year = (390000*106%-212720)*6% = $     12,041 PV of tax shield on interest = 23400*0.35/1.06+12041*0.35/1.06^2 = $     11,477 3) APV = 190165+11477 = $ 2,01,642

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