MVP Inc has produced rodeo supplies for over 20 years. The company currently has a debt-equity ratio of 50% and is in the 40% tax bracket. The required return on the firm’s levered equity is 16%. MVOP is planning to expand its production capacity. The equipment to be purchased is expected to generate the following unlevered cash flows (thus, not including any interest expense):
Year Cash Flow
0 -18,000,000
1 5,700,000
2 9,500,000
3 8,800,000
The company has arranged a debt issue of $9.3 million to partially finance the expansion. Under the loan, the company would pay interest of 9 percent at the end of each year on the outstanding balance at the beginning of the year. The company also would make year-end principal payments of $3.1 million per year, completely retiring the issue by the end of the third year. Using the adjusted present value method, should be company proceed with the expansion?
Answers: 2
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