Consider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.71 million per year for 10 years. The opportunity cost of capital is 11.45%, which reflects the project’s business risk.
a. Suppose the project is financed with $5 million of debt and $5 million of equity. The interest rate is 7.55% and the marginal tax rate is 35%. An equal amount of the debt principal will be repaid in each year of the project’s 10-year life.
Calculate APV.
b. If the firm incurs issue costs of $350,000 to raise the $5 million of required equity, what will be the APV?
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