Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 9 percent loan, with gross proceeds of $4,250,000. Kendrick's pretax cost of debt is 9 percent. Flotation costs are estimated to be 1.25 percent of gross proceeds and will be amortized using a straight-line schedule over the 10-year life of the loan. Kendrick is subject to a corporate tax rate of 40 percent. The loan will not increase the risk of financial distress for the firm.
1.Calculate the net present value of the loan excluding flotation costs.
2.Calculate the net present value of the loan including flotation costs.
The present value of the flotation cost tax shield is found.