Umikulsum

Chapter 17: Valuation and Capital Budgeting for the Levered Firm

17.1 a. The maximum price that Hertz should be willing to pay for the fleet of cars with all-equity funding

is the price that makes the NPV of the transaction equal to zero.

NPV = -Purchase Price + PV[(1- TC )(Earnings Before Taxes and Depreciation)] +

PV(Depreciation Tax Shield)

Let P equal the purchase price of the fleet.

NPV = -P + (1-0.34)($100,000)A50.10 + (0.34)(P/5)A50.10

Set the NPV equal to zero.

0 = -P + (1-0.34)($100,000)A50.10 + (0.34)(P/5)A50.10

P = $250,191.93 + (P)(0.34/5)A50.10

P = $250,191.93 + 0.2578P

0.7422P = $250,191.93

P = $337,095

Therefore, the most that Hertz should be willing to pay for the fleet of cars with all-equity funding is $337,095.

b. The adjusted present value (APV) of a project equals the net present value of the project if it were funded completely by equity plus the net present value of any financing side effects. In Hertz’s case, the NPV of financing side effects equals the after-tax present value of the cash flows resulting from the firm’s debt.

APV = NPV(All-Equity) + NPV(Financing Side Effects)

NPV(All-Equity)

NPV = -Purchase Price + PV[(1- TC )(Earnings Before Taxes and Depreciation)] +

PV(Depreciation Tax Shield)

Hertz paid $325,000 for the fleet of cars. Because this fleet will be fully depreciated over five years using the straight-line method, annual depreciation expense equals $65,000 (= $325,000/5).

NPV = -$325,000 + (1-0.34)($100,000)A50.10 + (0.34)($65,000)A50.10

= $8,968

NPV(Financing Side Effects)

The net present value of financing side effects equals the after-tax present value of cash flows resulting from...