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ACCA Strategic Professional · Advanced Financial Management · Impact of financing on investment decisions and adjusted present values

Corvin plc is appraising a project costing $6 million. Base-case NPV at the ungeared cost of equity is -$90,000. The project supports debt of 50% of the initial cost, borrowed for three years on an interest-only basis at 8% before tax, with the tax rate at 25%. Issue costs are 2% of the debt raised, are not tax-deductible and are paid at time 0. Tax shields are discounted at 8%, and the three-year annuity factor at 8% is 2.577. What is the APV?

The APV is $4,620. Debt of $3m gives annual tax shields of $60,000, worth $154,620 over three years. After deducting $60,000 of non-deductible issue costs from the -$90,000 base-case NPV, the result is a small positive $4,620.

  1. A$4,620Correct
  2. B$64,620
  3. C$19,620
  4. D-$150,000

Explanation

Debt = $3m. Annual shield = $3m × 8% × 25% = $60,000, so PV = $60,000 × 2.577 = $154,620. Issue costs = 2% × $3m = $60,000. APV = -90,000 + 154,620 - 60,000 = $4,620. $64,620 omits issue costs. $19,620 wrongly gives tax relief on issue costs. -$150,000 omits the tax shield.

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