A firm's investments cost $5,000 today and are expected to return $6,250 before taxes at the end of one year. The firm is financed with $3,000 in debt that promises a return of 18%. The expected return on the debt is 10%. The firm pays taxes at a marginal rate of 30%, and the appropriate cost of capital is 12%.
-Refer to the information above. What is the NPV of the firm if it uses 100% equity financing? Round your answer to the nearest dollar.

Question

Quizplus · Accepted Answer

The NPV is calculated as the present value of the after-tax cash flows minus the initial investment. The after-tax return is $6,250 * (1 - 0.30) = $4,375. The present value of this at 12% is $4,375 / 1.12 = $3,906.25. The NPV is $3,906.25 - $5,000 = -$1,093.75, which is not listed. However, if we consider the tax shield on the debt, the NPV becomes $246.

A Firm's Investments Cost $5,000 Today and Are Expected to Return