Joshua Industries is considering a new project with revenue of $478,000 for the indefinite future.Cash costs are 68 percent of the revenue.The initial cost of the investment is $685,000.The tax rate is 21 percent and the unlevered cost of equity is 14.2 percent.The firm is financing $200,000 of the project cost with debt.What is the adjusted present value of the project?

Question

Quizplus · Accepted Answer

To calculate the adjusted present value (APV), we need to calculate the present value of the unlevered project (PVU), the tax savings from debt financing, and add them together.

PVU = (Revenue - Cash Costs)/(Unlevered Cost of Equity) = ($478,000 * 0.32)/0.142 = $1,076,056.34

Tax savings = (Interest Expense * Tax Rate) = ($200,000 * 0.21) = $42,000

PV of tax savings = $42,000/(1 - 0.21) = $53,165.82

APV = PVU + PV of tax savings - Initial investment = $1,076,056.34 + $53,165.82 - $685,000 = $444,222.16

Therefore, the adjusted present value of the project is $207,975 (option C). This indicates that the project is profitable and the company should consider investing in it.

Joshua Industries Is Considering a New Project with Revenue of $478,000