The contract is expected to produce after-tax cash flows of 45 million per annum for five years. The investment will need 135 million of financing. The company is considering various mixes of financing, from 100% equity through to 65% equity and 35% debt financing. The company can borrow at 7.5%. Whatever sum the company borrows for the project, it will repay all the principal back to the end of year 5 in the one payment. Interest would be paid annually on the outstanding principal. It will cost Neptune to raise funds from the markets. Equity finance will have issue costs to the company of 10% of whatever sum it raises. With debt finance the issue costs for borrowing would be 5% of the sum raised. Neptune needs a net 135m to invest in the project. The company tax rate is 25%. Senior management have asked you to evaluate the attractiveness to shareholders (i.e. wealth maximisation) of the two options: all-equity funding or 35% debt funding. They want you to conduct the analysis using the Adjusted Present Value (APV) method. With the debt funding proportion (i.e. 65% equity and 35% debt), the debt beta will be 0.32 and the equity beta will be 1.495. The risk-free rate of interest is 5.5% and the market risk premium is 6%.

QUESTION Calculate the APV of the project if it was funded with 35% new debt and 65% new equity. Comment on the suitability of the project under the different funding arrangements.