Blue Gills Corporation is looking to build a toll road in Iowa. The initial investment in paving equipment is $81 million. The equipment will be fully depreciated using the straight-line method over its economic life of ten years. Earnings before interest, taxes, and depreciation collected from the toll road are projected to be $6.8 million per annum for 20 years starting from the end of the first year. The corporate tax rate is 40 percent. The required rate of return for the project under all-equity financing is 9.5 percent. The private, pretax cost of debt is 7.6 percent. To encourage investment in the country’s infrastructure, the U.S. government could subsidize the project with a $36 million, 15-year loan at an interest rate of 4.5 percent per year. All principal will be repaid in one balloon payment at the end of Year 15.
a. What is the value of this project using the private debt financing with equity? (Hint: APV)
b. What is the value of this project WITH the loan subsidy combined with equity?