The city of Princeton, MN (bond rating Baa) is considering a tax-increment
district for financing a downtown development project. The city
must raise $400,000 for the project. The project will generate
$94,000 a year, once it is in place; the city estimates it will
take 2 years before any tax-increment revenues are generated.
Surplus earnings will be invested at 7%. Bond rates are projected
at 7.25% for the first year, and will increase at .25% each year,
to a maximum of 9.0%.
1. Assume the city capitalizes $60,000 of the interest. What
is the payback period and the pattern of debt coverage for this
project?
3. Using the original assumptions, compare the effect of $30,000
capitalized interest and $60,000 capitalized interest on the feasibility
of the project.
4. Suppose the city's bond rating is upgraded to A. At this
rating, bonds start at 7.0%, and increase in the following pattern:
7.0%, 7.2%, 7.4%, 7.75%, 7.9%, etc. What difference does this
make in the feasibility of the project?
5. Suppose interest rates jump by 1%. What is the effect on project feasibility? What schedule of debt repayment would be necessary to make the project work?