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?

Question

Quizplus · Accepted Answer

To calculate the present value of the interest subsidy, we first need to find the amount of interest saved by the borrower due to the subsidized rate. The savings per year would be (10%-7%)*$12 million = $360,000. 
To find the present value of this savings over 8 years, we need to discount each year's savings to its present value using the subsidized rate of 7%. Using the formula for present value of an annuity, the present value of the interest subsidy is:
PV = $360,000 * ((1 - (1/1.07^8))/0.07) = $1.92 million. 
Therefore, the correct answer is B.

An Investment in the Mezzogiorno Will Receive a Subsidized Loan