Company X is planning an investment in an environmental protection project, whic

Question

Company X is planning an investment in an environmental protection project, which has a base NPV of -€600,000. The local government has offered Company X a subsidized loan of €12 million for this project, which will carry an interest rate of 3% annually. Company X is required to pay the interest only at the end of the year for 3 years and to repay the entire principal amount at the end of third year. Company X’s current borrowing rate is 8% and its marginal tax rate is 30%. Given this subsidized loan, should Company X invest in the project or not?

Is the answer as simple as no they shouldn't as the NPV is not positive or zero or does this situation change under these conditions? Thankyou!

Explanation / Answer

Without subsidized loan NPV is $ - 600,000. Status may be different, if we consider changes in cash flow due to this loan. So, change in NPV = NPV of savings in interest payments after tax, for 3 years + savings due to lower NPV of principal payment =12,000,000*(0.08 -0.03)*(1-0.3)(1/1.08)(1-1/1.08^3)/(1-1/1.08) + 12,000,000(1 - 1/1.08^3) = 4,198,925 (nearest Dollar) So net NPV after subsidized loan = - 600,000 + 4,198,925 = 3,598,925 ($) Hence NPV HAS BECOME POSITIVE AND LUCRATIVE, AND SO COMPANY MUST INVEST (ANSWER)

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