The Wiiliams Bennett Hotel Development Corp., has identified a historic bank building that could be converted into a hotel. The location is in the heart of downtown Smithon, a densely populated metropolitan city. The structure was designed by an acclaimed architect and built in 1913. The fifteen-story building will be transformed into a chic-boutique hotel with the hotel lobby, meeting rooms, cafe, and fitness area on the first two floors. The remaining 13 floors will contain 130 rooms.

The entire project will cost $35,000,000. 60% of the project cost will be financed thru debt (21,000,000), $14,000,000 is being provided by equity investors. The lender is offering a favorable 12% interest rate on the 21,000,000, and the equity investors are requiring a return of 18% on their investment. The current business tax rate is 25%.

Because the structure is historic, the Williams Bennett Hotel Development Co. has been in discussions with the city government to determine if there are any public incentives for redeveloping this property. The development company knows the hotel supply in Smithon is undeserved and that the city needs additional rooms to attract larger convention groups. The city would also gain from additional jobs, which would lower the unmeployment rate. There are obvious benefits for both the city and development company .

Two Questions.

• Explain the tax effect and its relation to the interest portion of debt service.

In this case, the city government offered Williams Bennett a tax abatement in the amount of $1,000,000 spread evenly over the first five years of operation. Explain how the tax abatement impacts the company's ability to pay debt service.