Question

Red 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 $80.1 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 $10.8 million per annum for 20 years starting from the end of the first year. The corporate tax rate is 21 percent. The required rate of return for the project under all-equity financing is 12 percent. The pretax cost of debt for the joint partnership is 8.6 percent. To encourage investment in the country’s infrastructure, the U.S. government will subsidize the project with a $25.1 million, 15-year loan at an interest rate of 5.1 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.

Answer 1