Problem
Benton is a rental car company that is trying to determine whether to add 25 cars to its fleet. The company fully depreciates all its rental cars over five years using the straight-line method. The new cars are expected to generate $210,000 per year in earnings before taxes and depreciation for five years. The company is entirely financed by equity and has a 25 percent tax rate. The required return on the company's unlevered equity is 15 percent and the new fleet will not change the risk of the company. The risk-free rate is 4 percent.
1) What is the maximum price that the company should be willing to pay for the new fleet of cars if it remains an all-equity company?
2) Suppose the company can purchase the fleet of cars for $645,000. Additionally, assume the company can issue $410,000 of five-year debt to finance the project at the risk-free rate of 4 percent. All principal will be repaid in one balloon payment at the end of the fifth year. What is the APV of the project?