1. Gastronome is a well-known manufacturer of frozen foods in the United States. They are considering a proposal to manufacture their GourmetTM brand of high quality frozen foods in the United Kingdom. One inducement to make the investment is subsidised financing in the form of a six-year loan of $20 million at 4% per annum. This loan would be repayable in six equal end-year payments. Additional information includes:

Gastronome cost of equity 24%

Market cost of debt (unsubsidised) 10%

Optimal capital structure 40% debt, 60% equity UK T-Bill rate 8% Corporate tax rate, USA and UK 34%

(a) What discount rate should Gastronome use to evaluate the proposed project?

(b) Would you recommend that Gastronome undertake this investment? Explain fully.

(c) What is the value of the subsidised loan? How would such a loan affect Gastronomes capital budgeting analysis? What (if any) are the controversial aspects?