Untitled-29

Capital Structure Theories^287

Year Loan at the Interest Principal Loan at Interest

Beginning Repayment the End Tax Shield

0 - - - 24 -

1 24 3.60 - 24 1.26

2 24 3.60 - 24 1.26

3 24 3.60 - 24 1.26

4 24 3.60 - 24 1.26

5 24 3.60 - 24 1.26

6 24 3.60 8 16 1.26

7 16 2.40 8 8 0.84

8 8 1.20 8 0 0.42

The projectís APV can be calculated by using Equation (40):

APV =

12

1 118

8

i= (. )t

1 26

1 115

(^6).
i= (. )t
L
N
M




• + 
  
  
  
  
  
  

= (12 ◊ 4.0776) + [1.26 ◊ 3.7845 + 0.84 ◊ 0.3759 + 0.42 ◊ 0.3269]

= 48.93 + [4.77 + 0.32 + 0.141 = 48.93 + 5.23 = Rs 54.16

The adjusted net present value (ANPV) is:

ANPV = APV - Initial Cost = 54.16 - 64 = - Rs 9.84

Since ANPV is negative, the project should not be accepted.

What will happen to the projectís ANPV if the company is able to negotiate loan of
Rs 24 crore at concessional interest rate of 10 per cent from the government if it
agrees to start the project in a backward area? If the market interest rate is assumed
to be 15 per cent, the project gets a ësubsidyí of 5 percent. Also, it will get interest tax
shield. The interest subsidy and interest tax shields are calculated as follows (assuming
that loan is repaid in equal instalments at the end of years 6, 7 and 8):
Year Interest Interest Tax
Subsidy Shield

1. (0.15 - 0.10) 24 = 1.20 0.35 ◊ 0.10 ◊ 24 = 0.84


2. (0.15 - 0.10) 24 = 1.20 0.35 ◊ 0.10 ◊ 24 = 0.84


3. (0.15 - 0.10) 24 = 1.20 0.35 ◊ 0.10 ◊ 24 = 0.84


4. (0.15 - 0.10) 24 = 1.20 0.35 ◊ 0.10 ◊ 24 = 0.84


5. (0.15 - 0.10) 24 = 1.20 0.35 ◊ 0.10 ◊ 24 = 0.84


6. (0.15 - 0.10) 24 = 1.20 0.35 ◊ 0.10 ◊ 24 = 0.84


7. (0.15 - 0.10) 16 = 1.20 0.35 ◊ 0.10 ◊ 16 = 0.84


8. (0.15 - 0.10) 8 = 1.20 0.35 ◊ 0.10 ◊ 8 = 0.84

The project APV will be: