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ACCA Strategic Professional · Advanced Financial Management · International investment and financing decisions

Kestrel plc is evaluating an overseas project. Base-case NPV, discounted at the ungeared cost of equity, is $2.40 million. Issue costs on the funding are $0.30 million (net of tax relief). The project supports debt of $5 million at 6% for four years, with the principal repaid at the end of year 4. Tax rate is 25% and the tax shield is discounted at the pre-tax cost of debt of 6%. Annuity factor for 4 years at 6% is 3.465. What is the APV (to the nearest $0.01 million)?

The APV is the base-case NPV of $2.40m less issue costs of $0.30m plus the present value of the tax shield, $0.075m a year for four years at 3.465, which is about $0.26m, giving roughly $2.36m.

  1. A$2.26 million
  2. B$2.62 millionCorrect
  3. C$2.32 million
  4. D$2.56 million

Explanation

Annual tax shield = 5m x 6% x 25% = $0.075m. PV = 0.075 x 3.465 = $0.26m. APV = 2.40 - 0.30 + 0.26 = $2.36m... recomputed precisely: 0.075 x 3.465 = 0.2599, so APV = 2.3599, about $2.36m.

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