question archive An investment in the Mezzogiorno will receive a subsidized loan of $12 million from the Italian government
An investment in the Mezzogiorno will receive a subsidized loan of $12 million from the Italian government
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An investment in the Mezzogiorno will receive a subsidized loan of $12 million from the Italian government. The loan bears an interest rate of 7% in contrast to a market rate of 10%. The loan principal must be paid back in 8 years. What is the present value of the interest subsidy?
a) $360,000
b) $1.92 million
c) $2.31 million
d) $870,000
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b) $1.92 million
Step-by-step explanation
Calculation of PV of interest subsidy
Market interest rate = 10%
Subsidized interest rete = 7%
Interest subsidy per year = 12 million * (10% - 7%) = 0.36 million
PV of interest subsidy = 0.36 / (1+10%) + 0.36 / (1+10%)2 + 0.36 / (1+10%)3 + . . . + 0.36 / (1+10%)8
PV of interest subsidy = 0.36 * [1 - (1+10%)-8]/10%
PV of interest subsidy = 0.36 * 5.33493 = 1.92
PV of interest subsidy is $1.92 million
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