Consider a project to produce solar water heaters. It requires a $10 million
investment and offers a level after-tax cash flow of $1.75 million per year for 10
years. The opportunity cost of capital is 12 percent, which reflects the project's
business risk. Suppose the project is financed with $5 million of debt and $5 million of
equity. The interest rate is 8 percent and the marginal tax rate is 35
percent. The debt will be paid off in equal annual installments over the
project's 10-year life.
A) Calculate APV.
B) How does APV change if the firm incurs issue costs of $400,000 to raise the $5 million of required equity?
The solution explains how to calculate the adjusted present value (APV)