Question Tag: Government Subsidy

One-Village Water Resources Ltd (One-Village) is considering a damming and irrigation project that will supply water to tomato farms around the Oti River. One-Village plans to commence the construction and installation phase of the project immediately and complete it in three years. One-Village will invest GH¢3 million in new plants and equipment now. Mobilisation to the project site will cost GH¢0.5 million now. Development costs are expected to be GH¢3 million in the first year, GH¢4 million in the second year, and GH¢2 million in the third year.

The commercial phase of the project will commence in the fourth year and run indefinitely. The project will generate after-tax net cash flows of GH¢6 million in the fourth year and GH¢8 million in the fifth year. Beyond the fifth year, cash flows will grow by 5% every year to perpetuity.

One-Village has 10 million shares outstanding, which are currently trading at GH¢3.5 each. The total value of its debt stock is GH¢20 million. One-Village plans to finance the investment requirements of the construction and installation phase of the project with new debt. Its borrowing cost is 20%, while its cost of equity is 25%. The Government of Ghana is promoting large-scale farming and is willing to give a subsidised loan of up to GH¢10 million at 15% annual interest. One-Village plans to take the maximum subsidised loan from the Government of Ghana and finance the balance with a bank loan. Issue costs, which are tax-deductible, are expected to be GH¢0.6 million. Both loans will be repaid in five years. One-Village falls into the 22% corporate income tax category. The risk-free interest rate is 14%, and the return on the market portfolio is 18%.

Required:
Evaluate the project using the adjusted present value (APV) technique and recommend whether it should be implemented or not. (12 marks)