Triad Corporation has established a joint venture with Tobacco Road Construction

Question

Triad Corporation has established a joint venture with Tobacco Road Construction, Inc., to build a toll road in North Carolina. The initial investment in paving equipment is $80 million. The equipment will be fully depreciated using the straight-line method over its economic life of five years. Earnings before interest, taxes, and depreciation collected from the toll road are projected to be $12.1 million per annum for 20 years starting from the end of the first year. The corporate tax rate is 35 percent. The required rate of return for the project under all-equity financing is 13 percent. The pretax cost of debt for the joint partnership is 8.5 percent. To encourage investment in the country’s infrastructure, the U.S. government will subsidize the project with a $25 million, 15-year loan at an interest rate of 5 percent per year. All principal will be repaid in one balloon payment at the end of Year 15.

What is the adjusted present value of this project?

Explanation / Answer

Solution :

Initial investment = $ 80,000,000

Debt = $ 25,000,000

Proportion of debt = 31.25 %

Proprtion of equity = 68.75 %

WACC = We re + Wd rd ( 1-tc )

WACC = 0.6875 X 0.13 + 0.3125 X 0.085 ( 1-0.35)

WACC = 10.66%

The baloon payment at end of year 15 = $ 25,000,000 ( 1+0.05) 15

Payment at the end of 15 year = $ 51,973,205

The adjusted present value of this project = -$ 80,000,000 + $ 71,614, 365.37

The adjusted present value of this project = -$ 8,385,634.63

Year Cash outflows Depreciation per year Cash Inflows Net cash flow = (Revenue - expenses - depreciation) X tax rate + depreciation Present value of Net cash flows 0 $80,000,000.00 1 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 8372492.319 2 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 7565960.888 3 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 6837123.521 4 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 6178495.862 5 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 5583314.533 6 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 5045467.678 7 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 4559432.205 8 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 4120217.066 9 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 3723312.006 10 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 3364641.249 11 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 3040521.642 12 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 2747624.835 13 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 2482943.1 14 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 2243758.449 15 $51,973,205.00 $4,000,000.00 $12,100,000 -$8,267,583.25 -1809333.351 16 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 1832292.355 17 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 1655785.609 18 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 1496281.953 19 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 1352143.46 20 $0.00 $4,000,000.00 $12,100,000 $9,265,000.00 1221889.987

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