Red Dirt Paving Inc. is a small business, engaged in urban and rural road construction projects. They are exploring the possibility of a $2.5 million dollar investment in new excavation, stabilization, and paving machineries. On annual basis, they estimate, this new investment will generate $300,000 operating profit for the next ten years.

a. Compute the net present value for this investment under a 2.5% rate of interest, assuming that RDP is able to raise the required investment funds internally through its shareholders. The entire investment cost is paid at the beginning of the period during which net present value computation is conducted: t=0. The extra operating profit generated by this investment is received at the beginning of each subsequent periods: t=1, t=2, ..., t=10. In a short paragraph, describe your solution and the formula that you used for computation (15 points: 5 points for the computed net present value and 10 points for the description of the solution and formula).

b. During a board meeting, two of the board members object to the applied interest rate, arguing that it underestimates the opportunity cost of the investment funds. In their view, 4% is a more accurate interest rate. Under the assumptions in part a, re-compute the net present value for this investment using a 4% rate of interest. Then, reflect upon your findings: does the revised interest rate make the board members more patient or less patient? (10 points: 5 points for the computed net present value and 5 points for the reflections on board member patience).

c. After a lengthy discussion and consultation with their bank, the board members agree on 4% to be a more accurate interest rate. Consulting with their bank, however, they learn that they also qualify for a heavily subsidized loan that could finance up to $500,000 of their investment. Considering this loan option, they invest only $2 million worth of internal funds at t=0. They also pay $58,616 per year to service their loan, starting from t=1 and ending by t=10.[1] Recompute the net present value for this investment. Then, reflect upon your findings: does the loan offer provide any incentives for the board members to engage in this investment? (10 points: 5 points for the computed net present value and 5 points for the reflections on board member patience).

[1] The annual loan payment is based on a subsidized loan for $500,000 paid back in 10 years with 3% interest rate.