Initial government estimates indicate that the Portpatrick-Larne Bridge would cost $18.75 billion ($18,750,000,000) with costs spread equally over the first five years ($3.75B a year). Assume that once the bridge is completed it will last indefinitely with proper maintenance and produce cash flows of $200 million ($200,000,000) per year net of maintenance expenses. Unless otherwise indicated you may assume that the project's cost of capital is the 30 year interest rate on UK government bonds (called Gilts) of 0.86% per year. For simplicity, assume that interest is paid annually. FYI, this is a real project under consideration and some of the numbers in this problem were taken from press accounts of the project. 1.5 (10) The government wants to issue a special longer term bond to fund the project. They are unsure of what the interest rate they will get on this financing. Is there a minimum interest rate at which the bridge is a positive NPV project? Is there a maximum interest rate at which the bridge is a positive NPV project? What is the rate of interest when the NPV is zero? What do we call this special interest rate? In this setting, do we know if this interest rate is unique? (10) Until now, we have assumed that the cash-flows of the project are constant. Let's relax that assumption and explore the consequences on the appropriate cost of capital for the Portpatrick-Larne Bridge. The finance ministry estimates that if the bridge were built in the year 2000, the returns in each year would be as follows: 1.6 8.1 Year Rate of Return on the Bridge (%) Return of UK Stock Market (%) Ri Year Rate of Return on the Bridge (%) Return of UK Stock Market (%) R 2000 3.0 -6.2 5.8 2010 5.2 12.6 2001 1.5 - 12.2 5.0 2011 1.4 -2.2 2002 -1.1 -20.5 4.8 2012 4.0 10.0 2003 17.9 4.2 2013 6.1 18.7 2004 6.9 11.2 4.8 2014 1.7 0.7 2005 9.2 20.8 4.4 2015 1.4 -1.3 2006 14.4 4.6 2016 6.2 19.1 2007 6.5 7.4 5.2 2017 4.4 12.0 2008 -3.0 -28.3 4.2 2018 -0.5 -8.7 2009 9.2 27.3 2.7 2019 5.3 17.3 Assume that going forward a similar relationship will hold. The expected return on the UK stock market is 9% per year. The expected risk free rate over the life of project is 1%. What cost of capital capital is appropriate for the bridge? If this is the appropriate cost of capital, how does this change your answer to 1.3? 7.4 Initial government estimates indicate that the Portpatrick-Larne Bridge would cost $18.75 billion ($18,750,000,000) with costs spread equally over the first five years ($3.75B a year). Assume that once the bridge is completed it will last indefinitely with proper maintenance and produce cash flows of $200 million ($200,000,000) per year net of maintenance expenses. Unless otherwise indicated you may assume that the project's cost of capital is the 30 year interest rate on UK government bonds (called Gilts) of 0.86% per year. For simplicity, assume that interest is paid annually. FYI, this is a real project under consideration and some of the numbers in this problem were taken from press accounts of the project. 1.5 (10) The government wants to issue a special longer term bond to fund the project. They are unsure of what the interest rate they will get on this financing. Is there a minimum interest rate at which the bridge is a positive NPV project? Is there a maximum interest rate at which the bridge is a positive NPV project? What is the rate of interest when the NPV is zero? What do we call this special interest rate? In this setting, do we know if this interest rate is unique? (10) Until now, we have assumed that the cash-flows of the project are constant. Let's relax that assumption and explore the consequences on the appropriate cost of capital for the Portpatrick-Larne Bridge. The finance ministry estimates that if the bridge were built in the year 2000, the returns in each year would be as follows: 1.6 8.1 Year Rate of Return on the Bridge (%) Return of UK Stock Market (%) Ri Year Rate of Return on the Bridge (%) Return of UK Stock Market (%) R 2000 3.0 -6.2 5.8 2010 5.2 12.6 2001 1.5 - 12.2 5.0 2011 1.4 -2.2 2002 -1.1 -20.5 4.8 2012 4.0 10.0 2003 17.9 4.2 2013 6.1 18.7 2004 6.9 11.2 4.8 2014 1.7 0.7 2005 9.2 20.8 4.4 2015 1.4 -1.3 2006 14.4 4.6 2016 6.2 19.1 2007 6.5 7.4 5.2 2017 4.4 12.0 2008 -3.0 -28.3 4.2 2018 -0.5 -8.7 2009 9.2 27.3 2.7 2019 5.3 17.3 Assume that going forward a similar relationship will hold. The expected return on the UK stock market is 9% per year. The expected risk free rate over the life of project is 1%. What cost of capital capital is appropriate for the bridge? If this is the appropriate cost of capital, how does this change your answer to 1.3? 7.4