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 $161 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 $24.7 million per annum for 20 years starting from the end of the first year. The corporate tax rate is 24 percent. The required rate of return for the project under all-equity financing is 15 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 $85 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.

What is the adjusted present value of this project?

Answer 1

CALCULATION OF APV

STEP1: Calculate Base Case NPV with cost of equity as the discount rate

Working(1) of Tax benefit

STEP 2: Calculation of PV of tax benefit from debt

Tax savings= Total value of debt*Tax rate* Pre-tax cost of debt

Then find its PV

STEP 3: Calculation of PV of cheap loans/subsidy

PV OF CHEAP LOANS= PV OF INTEREST SAVED- PV OF TAX BENEFIT LOST

STEP 4: SUM OF STEP 1 TO 3

APV= (-31)+9.71+34.4

=13.11