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APV Gemini, Inc., an all-equity firm, is considering a $2.4 million investment that will be depreciated according to the straight-line method over its four-year life. The project is expected to generate earnings before taxes and depreciation of $850,000 per year for four years. The investment will not change the risk level of the firm. The company can obtain a four-year, 9.5 percent loan to finance the project from a local bank.
All principal will be repaid in one balloon payment at the end of the fourth year. The bank will charge the firm $24,000 in flotation fees, which will be amortized over the four-year life of the loan. If the company financed the project entirely with equity, the firm's cost of capital would be 13 percent. The corporate tax rate is 30 percent. Using the adjusted present value method, determine whether the company should undertake the project.© BrainMass Inc. brainmass.com October 25, 2018, 2:23 am ad1c9bdddf
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Anna Liza Gaspar
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The adjusted present value method for undertaking the project is determined.
Weighted Average Cost of Capital (WACC), Adjusted Present Value
Collect the annual income statements of any company you know well for the last four fiscal years. The selected company must be in the process of expanding its business and plans to invest in a new investment project. As a newly hired MBA in the capital budgeting division you have been asked to evaluate a new project using the Weighted Average Cost of Capital (WACC), Adjusted Present Value (APV), and Flow-to-Equity (FTE) methods. You will need to compute the appropriate costs of capital and the net present values with each method. Because this is your first assignment with the company, they want you to demonstrate your ability to apply the different methods of project evaluation. You must seek required information necessary to determine the free cash flows. Create a spreadsheet in Excel to do all your calculations.
1-Determine the WACC for the company. Compute the NPV of the new project based on the free cash flows you calculated using the WACC method.
2-Determine the NPV using the APV and FTE methods. In both cases, assume the company maintains the target leverage ratio you computed in WACC.
3- Compare the results under the three methods and explain how the resulting NPVs are achieved under each of the three different methods.
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