Skip to content

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

Zenta Ltd is considering a project costing $10m now. It will generate after-tax operating cash flows of $3m a year for 5 years, discounted at an ungeared cost of equity of 10% (5-year annuity factor 3.7908). Zenta will raise $4m of 5-year interest-only debt at a pre-tax rate of 6% (5-year annuity factor at 6% is 4.2124). The tax rate is 25%. The tax shield is discounted at the pre-tax cost of debt and issue costs are ignored. What is the APV?

The APV is $1.625m. The base-case NPV at the 10% ungeared rate is $1.372m. The tax shield is $0.06m a year, which is $4m x 6% x 25%. At 6% its present value is $0.253m. Adding the two gives $1.625m.

  1. A$1.625mCorrect
  2. B$1.600m
  3. C$1.372m
  4. D$2.383m

Explanation

Base-case NPV = 3m x 3.7908 - 10m = $1.3724m. Annual tax shield = 4m x 6% x 25% = $0.06m; PV at 6% = 0.06 x 4.2124 = $0.2527m. APV = 1.3724 + 0.2527 = $1.625m. Discounting the shield at 10% gives $1.600m, which is wrong because the shield has debt-like risk. Omitting it gives $1.372m, and omitting the tax rate gives $2.383m.

Did you get it right without looking?

One question tells you little. A timed set on Impact of financing on investment decisions and adjusted present values shows your real accuracy, how long you take and where you lose marks.

Practise Impact of financing on investment decisions and adjusted present valuesFree diagnostic mock

More Impact of financing on investment decisions and adjusted present values questions