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Appendix 2b (Part (b) (ii)): Projects Alpha and Beta, adjusted present value (APV), in
six months’ time
Issue costs = 3/97 × Y$24,538,000 = Y$758,907
Annual tax shield = 2.1% × Y$24,538,000 × 20% = Y$103,060
Annual interest saved on subsidised loan = 2.9% × Y$24,538,000 × 80% = Y$569,282
Annuity factor, years 1 to 4 at 5% interest = 3.546
Present value of the tax shield and loan subsidy benefit = (Y$103,060 + Y$569,282) ×
3.546 = Y$2,384,125
Project Alpha APV Y$
Base case NPV of Project Alpha (appendix 2a) 5,272,000
Issue costs (758,907
Present value of the tax shield and loan subsidy benefit 2,384,125
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APV 6,897,218Pls explain this calculation part
You will have to say which bit of the calculation you are not clear about.
Always with APV calculations, we take the base case NPV and then adjust for the issue costs, the tax saving on debt, and any subsidy benefit (as explained in my free lectures).
Given that the issue costs are 3% of the gross proceeds, the net proceeds must be 97% and therefore the issue costs are 3/97 x 24,538,000.
The tax saving is 20% (tax rate) x 24,538,000 (borrowing) x 2.1% (interest rate) per year for 4 years and therefore the PV of the tax saving is the yearly saving discounted for 4 years (using the 4 year annuity factor at 5%).
The net of tax interest saved on the subsidised loan is 5 – 2.1 = 2.9% x the borrowing x 80% (i.e. after tax of 20%). This is the saving each year for 4 years and therefore we again discount for 4 years at 5% to get the PV of the saving.
Have you not watched my free lectures on APV?
Hello,
Just following on from this, why is an annuity factor of 5% used when the cost of this debt to the company is 2.1%?
Is it because we are also factoring in the 2.9% interest savings and foregone tax benefits?
https://youtu.be/hQZRRSOob0U?si=5OHw2cJGIpCrH6kn&t=1129 I think this answers it actually
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