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in the question above, i do not understand how the marking scheme calculates the subsidy benefit of 3,038,000.
it calculates it as 30600000*(0.05-0.022)*3.546however what do the numbers in bracket represent and why does the pv of benefit of the subsidy needs to be calculated?
0.05 (or 5%) is the normal cost of borrowing. 0.022 (or 2.2%) is the subsidised rate of interest. The difference is the benefit of the subsidy.
The Adjust Present Value calculations are based on Modigliani and Millers’ hypotheses and these assume the borrowing is at the ‘normal’ cost of borrowing. If there is a subsidised loan at a lower rate of interest than the normal rate, then there is an additional benefit of the after-tax amount.
This is explained in the chapter in our free lecture notes on the APV (part of ‘the impact of financing’ and the free lectures that work through the notes).
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