Case Scenario: Honda and GM are competing to sell a fleet of 25 cars to Hertz. Hertz fully depreciates all of its rental cars over five years using the straight-line method. The firm expects the fleet of 25 cars to generate $100,000 per year in earnings before taxes and depreciation for five years. Hertz is an all-equity firm in the 34-percent tax bracket. The required return on the firm's unlevered equity is 10 percent, and the new fleet will not add to the risk of the firm.
Question 1: What is the maximum price that Hertz should be willing to pay for the new fleet of cars if it remains an all-equity firm?
Question 2: Suppose Hertz purchases the fleet from GM for $325,000, and Hertz is able to issue $200,000 of five year, 8 percent debt in order to finance the project.All principal will be repaid in one balloon payment at the end of the fifth year.
Question 3: What is the adjusted present value (APV) of the project?