subsidy

I assume that you are referring to questions on the adjusted present value.

The subsidy benefit is the difference between the actual interest being charged and the normal rate of interest for the company, as applied to the amount of the loan.

There is tax relief on interest paid (as is obviously always the case) and if the tax relief has been calculated based on the normal interest rate on all the borrowing, then there is tax relief lost if some of the borrowing is at a subsidised rate.

Q22 The subsidy benefit is shown as the full difference in the interest. However because interest is tax allowable they are not getting (so are losing) the tax benefit on the difference in the interest.

Q23 To take account of the 30% tax benefit that is lost on the subsidised loan.

With APV, we show separately the tax benefit on any debt raised (as per Modigliani and Miller).

If there is a subsidised loan then there is also a benefit of the difference between the subsidised interest rate and the normal interest rate. However we will not get the tax benefit on the interest saved which is why it needs removing.

If the tax is 30% then the net benefit of the interest saved can be calculated as either the PV of interest saved less the PV of the tax on the interest saved (at 30%), or simply as 70% of the PV of the interest saved. It doesn’t matter which of the two ways you do it – they give the same result – unless there is a 1 year delay in the tax in which case the PV of the tax on the interest needs calculating separately from the PV of the interest saved.

Tax losses are relate to the investment appraisal and are not specific to APV calculations (and dealing with them is explained in my free lectures on investment appraisal).

Did you watch all of our lectures (or alternatively study all of the topics in your Study Text) before attempting questions in the Revision Kit?

You are welcome 🙂