Use the following information to answer the question(s)below.
Rearden Metal is evaluating a project that requires an investment of $150 million today and provides a single cash flow of $180 million for sure one year from now.Rearden decides to use 100% debt financing for this investment.The risk-free rate is 5% and Rearden's corporate tax rate is 21%.Assume that the investment is fully depreciated at the end of the year.
-The NPV of this project using the APV method is closest to:
A)$10 million.
B)$17 million.
C)$42 million.
D)$71 million.

Question

Quizplus · Accepted Answer

To calculate the NPV using the APV method, we need to calculate the value of the project as if it is all-equity financed and then adjust that value for the tax savings from debt financing.

First, let's calculate the value of the project as if it is financed entirely by equity:

PV of the project's cash flow = $180 million / (1 + 5%) = $171.43 million

Next, we need to calculate the tax savings from debt financing. Since the investment is entirely financed by debt, we can use the interest expense as a proxy for the tax savings. The interest expense is:

Interest expense = $150 million * 5% = $7.5 million

The tax savings from the interest expense is:

Tax savings = $7.5 million * 21% = $1.575 million

Finally, we need to adjust the value of the project to reflect the tax savings:

Adjusted project value = $171.43 million + $1.575 million = $172.99 million

The NPV of the project is:

NPV = $172.99 million - $150 million = $22.99 million

Therefore, the closest answer is B) $17 million.

Use the Following Information to Answer the Question(s)below