Hi! The following confuses me.

A company is looking at investing in an asset which will hopefully contribute to profit. At year zero, 70% of the investment will be covered by a dedicated loan with defined assumed constant interest rate r1, cost for interest paid each year. The remainder (30%) will be covered by the company’s mix of equity and other debts with defined WACC. The dedicated loan is under straight line amortization 20 years, starting from year 1. After 20 years, the asset will be sold.

So,disregarding details, how should I calculate the NPV? The thing that is confusing me is this dedicated loan.

When setting up the cash flows to be discounted, I’m uncertain and looking at different options.

Option 1)

Cash flow components:

Year 0:

- (neg) 30% of the investment (the part not covered by the dedicated loan)

Year 1,

- (neg) Amortization, 1/20 of the dedicated loan
- (neg) Interest payment of the dedicated loan
- (neg) Asset OPEX

- (pos) Positive cash flows generated by the asset (revenue)

Year n (years 2-19) (Much the same byt but interest payment for dedicated loan is decreasing)

- (neg) Amortization, 1/20 of the dedicated loan
- (neg) Interest payment of the remainder of the dedicated loan
- (neg) Asset OPEX

- (pos) Asset revenue

Year 20

- (neg) Amortization, 1/20 of the dedicated loan
- (neg) Interest payment of the remainder of the dedicated loan
- (neg) Asset OPEX

- (pos) Asset revenue
- (pos) Asset value when sold year end

Calculate NPV by adding the discounted summed cash flows from each year using the company WACC based on existing equity and dept (disregarding the separate loan for the investment)? I have a nagging feeling that including the interest payments and discounting these with the WACC is kind of doing things kind of twice even though the WACC and interest rate for the dedicated loan are different.

Other Options…

Should I instead treat the dedicated loan for 70% of the investment as just another portion of the company’s debt, causing a change in the WACC, and the WACC will change from year to year as the dedicated loan is amortized. Should year 0 then be the full initial investment (100%) neg cash flow? And then skip the negative components of cash flows each year 1-20 from amortization and interest pay, but instead focusing on adjusting the discount rate from year to year as the WACC will cange (as the relationship between equity and dept will change).

Confused - anyone out there who could help me understand? Thanks!