Your firm is in the 34 percent tax bracket.The yield to maturity on your existing bonds is 8 percent.The state of Georgia offers to loan your firm $1,000,000 with a two year amortizing loan at a 5 percent rate of interest and annual payments due at the end of the year. The interest will be deductible at the time that you pay.What is the APV of this below-market loan to your firm? I did not round any of my intermediate steps.You might be a little bit off.Pick the answer closest to yours.

Question

Quizplus · Accepted Answer

Step 1: Calculate the present value of the loan payments: 
PV = (PMT x (1 - (1 + r)^-n)) / r 
PV = ($567,078.07 x (1 - (1 + 0.05)^-2)) / 0.05 = $1,074,156.14

Step 2: Calculate the tax savings from the interest deduction: 
Tax savings = Interest expense x Tax rate
Tax savings = ($1,000,000 x 0.05) x 0.34 = $17,000

Step 3: Calculate the after-tax cost of the loan: 
AT cost = Loan cost - Tax savings 
AT cost = $1,074,156.14 - $17,000 = $1,057,156.14

Step 4: Calculate the APV: 
APV = AT cost - PV of the loan 
APV = $1,057,156.14 - $1,000,000 = $57,156.14

Therefore, the closest answer is (A) $64,157.38 (which is off by $7,001.24). So, the best choice is Answer: A

Your Firm Is in the 34 Percent Tax Bracket