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Honda and GM are competing to sell fleet of 25 cars to Hertz

Honda and GM are competing to sell a fleet of 25 cars to Hertz. Hertz fully depreciates all
of its rental cars over five years using the straight-line method. The firm expects the fleet of
25 cars to generate $100,000 per year in earnings before taxes and depreciation for five
years. Hertz is an all-equity firm in the 34-percent tax bracket. The required return on the
firm's unlevered equity is 10 percent, and the new fleet will not add to the risk of the firm.

a. What is the maximum price that Hertz should be willing to pay for the new fleet of cars
if it remains an all-equity firm?

b. Suppose Hertz purchases the fleet from GM for $325,000, and Hertz is able to issue
$200,000 of five year, 8 percent debt in order to finance the project.All principal will be
repaid in one balloon payment at the end of the fifth year.

c. What is the adjusted present value (APV) of the project?

Solution Preview

Honda and GM are competing to sell a fleet of 25 cars to Hertz. Hertz fully depreciates all of its rental cars over five years using the straight-line method. The firm expects the fleet of 25 cars to generate $100,000 per year in earnings before taxes and depreciation for five years. Hertz is an all-equity firm in the 34-percent tax bracket. The required return on the firm's unlevered equity is 10 percent, and the new fleet will not add to the risk of the firm.

a. What is the maximum price that Hertz should be willing to pay for the new fleet of cars if it remains an all-equity firm?

The maximum price that Hertz should be willing to pay for the fleet of cars with all-equity funding is the price that makes the NPV of the transaction equal to zero.

NPV = ...

Solution Summary

This solution is comprised of a detailed explanation to answer what is the maximum price that Hertz should be willing to pay for the new fleet of cars if it remains an all-equity firm and what is the adjusted present value (APV) of the project.

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