The large, consistently profitable firm you work for is considering the following small project. The firm is financed by 60% equity and 40% debt. The cost of equity is 10%. The cost of debt is 6%. The risk free rate is 6%. Corporate taxes are 40%. Debt capacity (the amount of risk free debt the project can support at that time) for the project, by period, is shown below.
Period-> 0 1 2 3
Expected Cashflow-> -$400 $200 $200 $200
Debt Capacity $250 $200 $150
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Get Help Now!a) Compute NPV using the WACC approach.
b) Compute NPV using the Adjusted Present Value (APV) approach. Assume the unlevered cost of capital is the same as the WACC in the absence of taxes.
c) Don’t forget to estimate the value of the tax shield.
d) Explain why these NPVs might differ.
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