Answer Happy

An all-equity firm is considering a $10,000,000 investment
that will be depreciated according to the straight-line method to
zero over its four-year life. The project is expected to generate
earnings before taxes and depreciation (EBTD) of $4,000,000 per
year for four years. The investment will not change the risk level
of the firm. The company can obtain a four-year, 8 percent loan to
finance the project from a local financial institution. Assume that
the firm will borrow $7,500,000. Interests will be paid every year
but all principal will be repaid in one balloon payment at the end
of fourth year. The bank will charge the firm $100,000 in flotation
fees, which will be amortized over the four-year life of the loan.
Depreciation and amortization expenses are tax-deductible. If the
company financed the project entirely with equity, the firm’s cost
of capital would be 15 percent. The corporate tax rate is 25
percent. The project does not require net working capital
investment and has no salvage value. Find the adjusted present
value (APV) of the project. Should the company accept the
project?