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Homework answers / question archive / Wilma is considering opening a widget factory
Wilma is considering opening a widget factory. The unlevered cost of equity for making widgets is 0.11. This factory would cost $16 million to set up, and would produce EBIT of $3 million per year for the foreseeable future. She is thinking of applying for a $10 million subsidized perpetual loan to finance this project. Complying with the auditing requirements of this loan would have a present value of $1 million. This loan would have a rate of 0.06, while the rate she could get from the bank is 0.07. Her tax rate is 0.41. What is the NPV of this project, using the APV method?
You Answered 5148051.95
Correct Answer
4,033,766 margin of error +/- 10,000
NPV of the project = PV of Cash Flows - Cost Minus loan amount - PV of loan - PV of debt
here,
PV of debt = (Initial Loan (1 - Tax) * subsidized loan rate) / market loan rate)
= 10 million* ( 1 - 0.41) * 0.06/0.07
= $ 5,057,142.86
PV of cash flows = EBIT * ( 1 - TAX RATE ) / COST OF EQUITY
= 3 million *( 1 - 0.41) /0.11
= 16090909.09
NPV of the project = 16090909.09 - ( 16 million - 10 million) - 1 million - $ 5,057,142.86
= $4033766.23 or $4033766
