Knotts, Inc., an all-equity firm, is considering an investment of $1.82 million that will be depreciated...

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Knotts, Inc., an all-equity firm, is considering an investmentof $1.82 million that will be depreciated according to thestraight-line method over its four-year life. The project isexpected to generate earnings before taxes and depreciation of$608,000 per year for four years. The investment will not changethe risk level of the firm. The company can obtain a four-year, 8.8percent loan to finance the project from a local bank. Allprincipal will be repaid in one balloon payment at the end of thefourth year. The bank will charge the firm $58,000 in flotationfees, which will be amortized over the four-year life of the loan.If the company financed the project entirely with equity, thefirm’s cost of capital would be 12 percent. The corporate tax rateis 22 percent.

Using the adjusted present value method, calculate the APV ofthe project. (Do not round intermediate calculations andenter your answer in dollars, not millions of dollars, rounded to 2decimal places, e.g., 1,234,567.89)

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Solution The adjusted present value of a project equals the net present value of the project under allequity financing and the net present value of any financing side effects APV NPV Allequity NPV See Answer

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Knotts, Inc., an all-equity firm, is considering an investmentof $1.82 million that will be depreciated according to thestraight-line method over its four-year life. The project isexpected to generate earnings before taxes and depreciation of$608,000 per year for four years. The investment will not changethe risk level of the firm. The company can obtain a four-year, 8.8percent loan to finance the project from a local bank. Allprincipal will be repaid in one balloon payment at the end of thefourth year. The bank will charge the firm $58,000 in flotationfees, which will be amortized over the four-year life of the loan.If the company financed the project entirely with equity, thefirm’s cost of capital would be 12 percent. The corporate tax rateis 22 percent. Using the adjusted present value method, calculate the APV ofthe project. (Do not round intermediate calculations andenter your answer in dollars, not millions of dollars, rounded to 2decimal places, e.g., 1,234,567.89)