"Assess how tax affects a project's valuation by evaluating the trade-offs of funding a project with debt vs equity and how the choice affects a projects value.

The following table shows the FCF of a project that lasts 10 years. The cost of capital of the project is 10% and the tax rate is 35%. The company running the project has an all-equity capital structure and decides to borrow against this project. The principal value of the loan, which is the amount that must be paid back to the lender either before or when the loan matures, is 150,000. In addition to the principal, coupons (a percentage of the principal amount) must be paid during the loan period, at predetermined intervals. In this case, the company pays annual coupons of 2.5% and its cost of capital for debt is 2.5%. The loan reaches maturity in 10 years, the money is raised in Year 0, and payment of coupons begins in Year 1.

Year FCF of project ()

Q1.2 Assuming the debt market is competitive, what is the NPV of raising this debt?

A E F F Year 0 1 2 3 4 5 6 7 8 9 10 B D FCF of Coupons Tax rebate project from coupon -435,000 0 0 -70,000 3,750 1,313 -28,000 3,750 1,313 77,000 3,750 1,313 97,000 3,750 1,313 99,000 3,750 1,313 112,000 3,750 1,313 115,000 3,750 1,313 130,000 3,750 1,313 133,000 3,750 1,313 234,000 3,750 1,313 Sum Total PV of tax PV of rebate at FCF at 10% 2.5% 0.00 -395,455 436.88 -63,636 426.23 -25,455 415.83 70,000 405.69 88,182 395.79 90,000 386.14 101,818 376.72 104,545 367.53 118,182 358.57 120,909 349.82 212,727 3,919.22 421,818