1. Zu car rental corporation is trying to determine whether to add 25 cars to its...

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1. Zu car rental corporation is trying to determine whether toadd 25 cars to its fleet. The company fully depreciates all itsrental cars over 5 years using the straight line method. The newcars are expected to generate $140,000 per year in earnings beforetaxes and depreciation for 5 years. The company is entirelyfinanced by equity and has a 35% tax rate. The required return onthe company’s unlevered equity is 13% and the new fleet will notchange the risk of the company.
a. What is the maximum price that the company should be willingto pay for the new fleet of cars if it remains an all-equityfirm?
b. Suppose the company can purchase the fleet of cars for$395,000. Additionally, assume the company can issue $260,000 for 5year, 8% debt to finance the project. All principal will be repaidin one balloon payment at the end of the 5th year. What is theadjusted present value (APV) of the project?
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3.7 Ratings (436 Votes)

a Calculation of Maximum Price Let Maximum price ie Present Value of Cash Outflow be denoted by A Net Present Value Present Value of Cash inflows Present Value of Cash Outflow 0 140000 1 035 Cumulative Present Value Factors for 5 Years at the rate of 13 020 A 035 Cumulative See Answer

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1. Zu car rental corporation is trying to determine whether toadd 25 cars to its fleet. The company fully depreciates all itsrental cars over 5 years using the straight line method. The newcars are expected to generate $140,000 per year in earnings beforetaxes and depreciation for 5 years. The company is entirelyfinanced by equity and has a 35% tax rate. The required return onthe company’s unlevered equity is 13% and the new fleet will notchange the risk of the company.a. What is the maximum price that the company should be willingto pay for the new fleet of cars if it remains an all-equityfirm?b. Suppose the company can purchase the fleet of cars for$395,000. Additionally, assume the company can issue $260,000 for 5year, 8% debt to finance the project. All principal will be repaidin one balloon payment at the end of the 5th year. What is theadjusted present value (APV) of the project?Show all work.