TTC is planning to raise $3.25 million for three years at an interest rate of 7.
ID: 2795345 • Letter: T
Question
TTC is planning to raise $3.25 million for three years at an interest rate of 7.35 percent to finance their expansion. The Alban County Board of Commissioners has just offered the firm the $3.25 million they need at 5.25 percent if the firm builds in Alban County, pays the interest annually, and repays the principal at the end of three years. What is the net present value of the loan to TTC if the firm’s tax rate is 34 percent and it accepts the county’s offer?
$329,245.19
$186,415.92
$293,651.12
$346,089.97
$212,100.00
Explanation / Answer
Amount that TTC is raising = $3.25 million
Term = 3 years
As per Offer by Alban County Board, initerest rate = 5.25% and principal is repayable at the end of 3 years
Tax rate = 34%
Interest paid by TTC for all years = Principal * interest = 3250000 * 0.0525 = $170,625
Prinicipal is same for every year as firm is paying only interest and principal will be paid at end of 3 years
Effective interest paid by firm = Interest*(1-tax) = 170625*(1-0.34) = $112,612.5 ( tax will be saved by interest as it is tax deductible so effective intrest paid will come after deducting the amount of tax saved)
Present value of interest = effective interest1/(1+r)1 + effective interest2/(1+r)2 + effective interest3/(1+r)3
Effective Interest is equal for all year as given above
r would be the interest rate that would be applied if loan is taken from outside i.e. 7.35%
Present value of interest = 112612.5/(1+0.0735)1 + 112612.5/(1+0.0735)2 + 112612.5/(1+0.0735)3
Present value of interest = $293,651.12
So the answer is option '3' i.e. $293,651.12
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