Info

530,625

180,413

1,019,588

2,500,000

Net Present Value at 18%: \$320,675

Net Present Value at 18%: \$320,675

Notes: Loan Amount: 0

Loan Finance Rate: 0% MARR 18%

Tax Rate 34%

MACRS Depreciation for 7-Year Property, with half-year convention at EOY 5 Accounting Book Value at end of year 5: 669,375

Estimated Market Value at end of year 5: 1,200,000

EOY 5* illustrates the Equipment Sale and Book Value

Taxable Income: =(Market Value - Book Value)

25.4.2.1 Application to the Case Study

Figure 25.7 illustrates the resource flows between the parties. In this arrangement, PizzaCo purchases the chilled water system with a loan from a bank. PizzaCo makes equal payments (principal + interest) to the bank for five years to retire the debt. Due to PizzaCo's small size, credibility, and inexperience in managing chilled water systems, PizzaCo is likely to pay a relatively high cost of capital. For example, let's assume 15%.

PizzaCo recovers the full \$1 million/year in savings for the entire five years, but must spend \$50,000/ year on maintenance and insurance. At the end of the five-year project, PizzaCo expects to sell the equipment for its market value of \$1,200,000. Tables 25.4 and 25.5 show the economic analysis for loans with a zero down payment and a 20% down payment, respectively. Assume that the bank reduces the interest rate to 14% for the loan with the 20% down payment. Since the asset is listed on PizzaCo's balance sheet, PizzaCo can use depreciation benefits to reduce the after-tax cost. In addition, all loan interest expenses are tax-deductible.

25.4.3 Bonds

Bonds are very similar to loans; a sum of money is borrowed and repaid with interest over a period of time. The primary difference is that with a bond, the issuer

(PizzaCo) periodically pays the investors only the interest earned. This periodic payment is called the "coupon interest payment." For example, a \$1,000 bond with a 10% coupon will pay \$100 per year. When the bond matures, the issuer returns the face value (\$1,000) to the investors.

Bonds are issued by corporations and government entities. Government bonds generate tax-free income for investors, thus these bonds can be issued at lower rates than corporate bonds. This benefit provides government facilities an economic advantage to use bonds to finance projects.

25.4.3.1 Application to the Case Study

Although PizzaCo (a private company) would not be able to obtain the low rates of a government bond, they could issue bonds with coupon interest rates competitive with the loan interest rate of 15%.

In this arrangement, PizzaCo receives the investors' cash (bond par value) and purchases the equipment. PizzaCo uses part of the energy savings to pay the coupon interest payments to the investors. When the bond matures, PizzaCo must then return the par value to the investors. See Figure 25.8.

As with a loan, PizzaCo owns, maintains and depreciates the equipment throughout the project's life. All coupon interest payments are tax-deductible. At the end

Table 25.4 Economic Analysis for a Loan with No Down Payment.

EOY Savings Depr. Payments Principal Taxable Tax ATCF

Principal Interest Total Outstanding Income

0 0