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

Orla plc is appraising a project costing $4m. The base-case NPV, discounted at the ungeared cost of equity of 8%, is $300,000. The project is financed by $2m of debt at 5% (the pre-tax cost of debt), interest-only, repaid in full at the end of year 4, which matches the project's finance period. Issue costs are $40,000, non-deductible for tax. Corporate tax is 30%. Tax shields are discounted at 5%. The 4-year annuity factor is 3.5460 at 5% and 3.3121 at 8%. What is the APV?

The APV is $366,380. The tax shield is $30,000 a year for four years, worth $106,380 at 5%. Adding this to the $300,000 base NPV and deducting $40,000 of issue costs gives $366,380. A perpetuity treatment would overstate the shield.

  1. A$366,380Correct
  2. B$359,363
  3. C$406,380
  4. D$860,000

Explanation

Annual tax shield = 2m × 5% × 30% = $30,000, for 4 years only. PV at 5% = 30,000 × 3.5460 = $106,380. APV = 300,000 + 106,380 − 40,000 = $366,380. Discounting the shield at 8% gives $359,363, ignoring issue costs gives $406,380, and treating the shield as a perpetuity gives $860,000.

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