A firm is considering a project to produce solar water heaters. The project requires a $10 million investment and offers a constant after-tax cash flow of $1.75 million per year for 10 years. The opportunity cost of capital for the project, which reflects the project’s business risk, equals 12%. With this information, please answer the following questions.
(i) What is the NPV of the project is if it is all-equity financed?
(ii) Suppose the firm can finance the project with $5 million in debt issued at a rate of 8% and that the marginal tax rate is 35%. The debt will be paid off in equal amounts over the project’s 10-year life. How does this affect the value of the project and the firm’s investment decision? Show your calculations. (hint: calculate the tax shields by projecting out the debt in each year).
The question belongs to Finance and it discusses about calculation of NPV of a project and calculation of debt.
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