Consider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.65 million per year for 10 years. The opportunity cost of capital is 10.55%, which reflects the project’s business risk.
a. Suppose the project is financed with $7 million of debt and $3 million of equity. The interest rate is 6.45% and the marginal tax rate is 34%. An equal amount of the debt principal will be repaid in each year of the project's 10-year life.
b. If the firm incurs issue costs of $500,000 to raise the $3 million of required equity, what will be the APV?