MVP, Inc., has produced rodeo supplies for over 20 years. The company currently

Question

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 14 percent. MVP is planning to expand its production capacity. The equipment to be purchased is expected to generate the following unlevered cash flows:

The company has arranged a $9.84 million debt issue to partially finance the expansion. Under the loan, the company would pay interest of 10 percent at the end of each year on the outstanding balance at the beginning of the year. The company would also make year-end principal payments of $3,280,000 per year, completely retiring the issue by the end of the third year.

Calculate the APV of the project.

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 14 percent. MVP is planning to expand its production capacity. The equipment to be purchased is expected to generate the following unlevered cash flows:

Explanation / Answer

APV = NPV + PV of debt financing advantages

NPV = -18850000 + [ (5880000 x 0.877) + (9680000 x 0.769) + (8980000 x 0.675) ]

= -$187820

PV of debt fin. adv. = (0.40 tax rate ($9840000 debt * 0.10 debt int.)) / (1 – (1 / (1 + 0.10 debt cost)))

= $10824000

APV = -187820 + 10824000

= $10636180

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