Copy Format 1 NPV and APV Zoso is a rental car company that

Copy Format 1. NPV and APV Zoso is a rental car company that is trying to determine whether to add 25 cars to its fleet. The company fully depreciates all its rental cars over five years using the straight-line method. The new cars are expected to generate $215,000 per year in earnings before taxes and depreciation for five years. The company is entirely financed by equity and has a 35 percent tax rate. The required return on the company\'s unlevered equity is 13 percent, and the new fleet will not change the risk of the company. a. What is the maximum price that the company should be willing to pay for the new fleet of cars if it remains an all-equity company? b. Suppose the company can purchase the fleet of cars for $650,000. Additionally assume the company can issue $430,000 of five-year debt to finance the project at the risk-free rate of 8 percent. All principal will be repaid in one balloon payment at the end of the fifth year. What is the adjusted present value (APV) of the project?

Solution

a. Earnings before taxes = 215,000

Earnings per year after taxes = 215,000*(1-0.35) = 139,750

Number of years = 5 (NPER = 5)

Annuity (PMT) = 139,750

rate = 13%

Present value =PV(rate,nper,pmt) in excel =rate(0.13,5,139750) = 491,533.07

So, the maximum that the company should be paying for the fleet of cars = $491,533

b. With a debt finance of 430,000 the Adjusted present value of the project is calculated as follows:

First we calculate the cost of capital:

Debt weight = 430000/650000 = 0.6615

Equity weight = 1-0.6615 = 0.3385

Cost of debt after tax = 8*(1-0.35)= 5.2%.

Cost of equity = 13%

WACC = 0.6615*5.2+0.3385*13% = 7.84%

We calculate the adjusted present value at this rate, 7.84%

Adjusted present value = $138,296.19

Year	0	1	2	3	4	5
Initial Cost	-220000
Earnings		215000	215000	215000	215000	215000
Depreiciation		-130000	-130000	-130000	-130000	-130000
Interest on loan		-34400	-34400	-34400	-34400	-34400
EBT		50600	50600	50600	50600	50600
Taxes at 35%		-17710	-17710	-17710	-17710	-17710
Net Income		32890	32890	32890	32890	32890
Add back depreciation		130000	130000	130000	130000	130000
Ballon principal repayment						-430000
Net cash flow	-220000	162890	162890	162890	162890	-267110
APV at 7.84%	$ 138,296.19