Question

Triad Corporation has established a joint venture with Tobacco Road Construction, Inc., to build a toll road in North Carolina. The initial investment in paving equipment is $80.2 million. The equipment will be fully depreciated using the straight-line method over its economic life of five years. Earnings before interest, taxes, and depreciation collected from the toll road are projected to be $12.3 million per annum for 20 years starting from the end of the first year. The corporate tax rate is 34 percent. The required rate of return for the project under all-equity financing is 13 percent. The pretax cost of debt for the joint partnership is 8.7 percent. To encourage investment in the country’s infrastructure, the U.S. government will subsidize the project with a $25.2 million, 15-year loan at an interest rate of 5.2 percent per year. All principal will be repaid in one balloon payment at the end of Year 15. The company issued subsidized debt instead of issuing debt at the terms it normally would. Assume the face amount and maturity of the debt issue are the same.

  

Calculate the gain or loss from subsidized debt. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Input the amount as a positive value. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

(Specify Gain or Loss) from subsidized debt

$

Answer 1

	Under normal terms
Loan amount in $	25200000
Term of the loan	15 years
Pretax cost of debt	8.70%
Pretax-cost of debt in $ per year	2192400
Tax amount on above@34% in $	745416
After tax cost of debt in $	1446984
Annuity factor for 15 years at 13% interest	6.462378823
Present value of interest payment	9350958.759	A
	Under subsidized terms
Loan amount in $	25200000
Term of the loan	15 years
Pretax cost of debt	5.20%
Pretax-cost of debt in $ per year	1310400
Tax amount on above@34% in $	445536
After tax cost of debt in $	864864
Annuity factor for 15 years at 13% interest	6.462378823
Present value of interest payment	5589078.799	B
Gain on subsidized debt=difference between above two present value	3761879.961	A-B