APV

Hello Mr John

My question is why are we not using interest rate at 2.2% (2.5% – 30 basis points) to calculate tax shield

And my other question is why is the value of the Subsidy not calculated this way

Saving
61.2m × (5% – 2.2%) × (1-0.3) × AF @ yr 5-yr1(since tax is paid 1 year in arrears)

When calculating
I got the base case NPV of -0.93 correct
PV of issue costs 2.55 correct

How ever PV of tax shield is wrong
As well as value of Subsidy

Question: Hazeltine Co

Background
Hazeltine Co is based in the USA. It is listed . Its directors collectively own 60% of the equity share capital with the balance owned primarily by financial institutions.
Hazeltine Co’s growth has been based upon the development of computer hardware primarily for smaller PC’s and tablet computers. However. the directors have taken a strategic decision to diversify operations and to invest in software to allow the remote exam invigilation (called proctoring) for the education sector. The directors believe this will be a fast-growing area as tt{i roll out of artificial intelligence (Al) continues to develop.

Jain Co
Jain Co is a large, listed company also based in the USA. Jain Co’s geared cost of equity is estimated to be and it has a WACC of 8%. Its asset beta is 1.25. The risk-free rate is 2.5 % and the equity risk premium is 5.2%.

Financing the investment
The innovative nature of this new venture will allow Hazeltine Co to finance all of the $61.2 million needed for the initial investment in the facilities via a subsidised government loan. The company has retained cash to fund the initial working capital required.
The govemment loan scheme will require it to be repaid at the end of the four years. Issue costs of 4% of the gross finance would be payable. These will be paid from retained cash reserves and are not tax allowable. Interest would be payable at a rate of 30 basis points below the risk-free rate of 2.5% currently, the standard bank loan interest rate for this type of loan stands at 5%pa.

Answer

3) PV of the tax shield on the interest to be paid

$61.2m × (2.50-0.30)% × Annuity Factor T2-T5 @ 5%
=1.36

4) PV of the Net of Tax Subsidy
Interest not paid
$61.2m × (5.00 -2.20)% × Annuity Factor T1-T4 @ 5%
=6.08

Tax shield lost
$61.2m × (5.00 – 2.20)% × -30% × AF T2 -T5 @5%
=-1.74

PV of the Finance Cash Flow
=3.15

Base case NPV -0.93
PV of the Finance
Cash Flow -3.15
APV 2.23