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Zoso 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 four years using the straight-line method. The new cars are expected to generate $150,000 per year in earnings before taxes and depreciation for four years. The company is entirely financed by equity and has a 35 percent tax rate. The required return on the company’s unlevered equity is 14 percent, and the new fleet will not change the risk of the company. The risk-free rate is 5 percent.
a. 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?
b. Suppose the company can purchase the fleet of cars for $365,000. Additionally, assume the company can issue $295,000 of four-year, 5 percent debt to finance the project. All principal will be repaid in one balloon payment at the end of the fourth year. What is the adjusted present value (APV) of the project?
What taxable yield is equivalent to a municipal bond yield of 5.8 percent if a taxpayer has a marginal tax rate of 43 percent?
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