The employees of the South Bend Lathe Co. were able to buy the entire common sto

Question

The employees of the South Bend Lathe Co. were able to buy the entire common stock (and hence ownership) of the company for $10 million in cash. The employees use a federal government plan known as Employee stock Ownership Plan, or ESOP, whereby the ESOP employee group was able to borrow the full purchase price of $10 million of which $5 million was lent by the US government to the ESOP for 25 years at 3% annual interest, and the other $5 million was obtained from Indiana banks at 4 percentage points above the prime rate (then at 9%).

In effect, the $5 million loan from the federal taxpayers at 3% for 25 years was a gift (or subsidy) of how much in present value terms? Use the interest paid to Indiana banks as the relevant cost of interest or the market rate.

4,538,520

Explanation / Answer

Difference in interest = 5000000*(13%-3%) = $        5,00,000 PV of the subsidy = 500000*(1.13^25-1)/(0.13*1.13^25) = $     36,64,992

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