Question

Blue Rabbit Corporation is looking to build a toll road in Kentucky. The initial investment in paving equipment is $184 million. The equipment will be fully depreciated using the straight-line method over its economic life of ten years. Earnings before interest, taxes, and depreciation collected from the toll road are projected to be $19.25 million per annum for 20 years starting from the end of the first year. The corporate tax rate is 25 percent. The required rate of return for the project under all-equity financing is 8.82 percent. This project could be privately financed by taking out a $100m loan over a nine-year period. The private, pretax cost of debt is 6.15 percent. Flotation costs would equal 1.4% of the loan total. Alternatively, to encourage investment in the country’s infrastructure, the U.S. government could subsidize the project with a $100 million, 9-year loan at an interest rate of 4.85 percent per year with zero flotation costs. For either loan, all principal will be repaid in one balloon payment at the end of Year 9. What is the NPV of the all equity project? Explain whether you would proceed with the project if it was an all-equity project. What is the value of this project using the private debt financing with equity? (Hint: APV) Explain whether you would pursue the project using this private debt financing. What is the value of this project with the subsidized loan? Explain whether you would pursue the project with the subsidized loan.

Answer 1

	Blue Rabbit corporation
	Calculation for Project of toll road
									(figures in millions)
	Description		All- Equity Financing			Private Debt			Subsidised Debt
	EBITDA for 20 years		$ 385.00			$ 385.00			$      385.00
	Less: Flotation Cost one time		$           -			$       1.40			$               -
	EBITDA for 20 years		$ 385.00			$ 383.60			$      385.00
	Less: Depriciation Amortised over 10 years		$ 184.00			$ 184.00			$      184.00
	EBIT for 20 years		$ 201.00			$ 199.60			$      201.00
	Less: Interest for 9 years		$           -			$    55.35			$        43.65
	EBT for 20 years/ Net Present Value		$ 201.00			$ 144.25			$      157.35
	Less: Tax @ 25%		$    50.25			$    36.06			$        39.34
	EAT		$ 150.75			$ 108.19			$      118.01
	Note: - Calculation is done for the twenty years
	All Equity Project: Net Present Value of project is $201 Millions. In my point of view it s the best option available in the three as the return is maximum in all the three available option, but there is dillution of ownership which should be kept in mind while selecting all equity option.
	Private Debt: Net Present Value of project is $108.19 Millions. If I was the owner it will be my last resort option available for financing as keeping terms same I am getting cheaper loan from US government.
	Subsidised Debt: Net Present Value of project is $118.01 Millions. It will be better option, if all equity option is not feasible as EPS will be higher in comparision to All equity option.