UPENN: LOOSE LEAF CORP.FIN W/CONNECT
UPENN: LOOSE LEAF CORP.FIN W/CONNECT
17th Edition
ISBN: 9781260361278
Author: Ross
Publisher: McGraw-Hill Publishing Co.
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Chapter 18, Problem 12QP

APV MVP, Inc., has produced rodeo supplies for over 20 years. The company currently has a debt-equity ratio of 50 percent and is in the 40 percent tax bracket. The required return on the firm's levered equity is 16 percent. The company is planning to expand its production capacity. The equipment to be purchased is expected to generate the following unlevered cash flows:

Year Cash Flow
0 -$15, 100,000
1 5,400,000
2 8,900,000
3 8,600,000

The company has arranged a debt issue of $8.7 million to partially finance the expansion. Under the loan, the company would pay interest of 9 percent at the end of each year on the outstanding balance at the beginning of the year. The company would also make yearend principal payments of $2,900,000 per year, completely retiring the issue by the end of the third year. Using the adjusted present value method, should the company proceed with the expansion?

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