Adjusted Present Value

Hi John,

Please can you let me know how the Ke as if ungraded is calculated in this question of Dec 2018 ?

Amberle Co is a listed company with divisions which manufacture cars, motorbikes and cycles. Over the last few years, Amberle Co has used a mixture of equity and debt finance for its investments. However, it is about to make a new investment of $150 million in facilities to produce electric cars, which it proposes to finance solely by debt finance.
Project information
Amberle Co’s finance director has prepared estimates of the post-tax cash flows for the project, using a four-year time horizon, together with the realisable value at the end of four years:
Year 1234 $m $m $m $m
Post-tax operating cash flows 28·50 36·70 44·40 50·90 Realisable value 45·00
Working capital of $6 million, not included in the estimates above and funded from retained earnings, will also be required immediately for the project, rising by the predicted rate of inflation for each year. Any remaining working capital will be released in full at the end of the project.
Predicted rates of inflation are as follows:
Year 1234
8% 6% 5% 4% The finance director has proposed the following finance package for the new investment:
Bank loan, repayable in equal annual instalments over the project’s life, interest
payable at 8% per year 70m
Subsidised loan from a government loan scheme over the project’s life on which
interest is payable at 3·1% per year 80m
150 ––––
Issue costs of 3% of gross proceeds will be payable on the subsidised loan. No issue costs will be payable on the bank loan. Issue costs are not allowable for tax

Financial information
Amberle Co pays tax at an annual rate of 30% on profits in the same year in which profits arise.
Amberle Co’s asset beta is currently estimated at 1·14. The current return on the market is estimated at 11%. The current risk-free rate is 4% per year.
Amberle Co’s chairman has noted that all of the company’s debt, including the new debt, will be repayable within three to five years. He is wondering whether Amberle Co needs to develop a longer term financing policy in broad terms and how flexible this policy should be.
Required:
(a) Calculate the adjusted present value (APV) for the project and conclude whether the project should be
accepted or not. (15 marks) (b) Discuss the factors which may determine the long-term finance policy which Amberle Co’s board may adopt
and the factors which may cause the policy to change. (10 marks)

Thank you
Noureen