4. You need to raise $1,000,000 to buy a dam that will provide energy to your town. Your tax rate is 40%. You would like to finance the transaction by issuing 20-year bonds at a 8% coupon rate, payable annually. (a) What is your before-tax and after-tax cost of money" (taking into account that the coupon payments on the bonds are tax-deductible, but not the repayment of principal in year 20), if the bonds sell for face value? Briefly discuss your results. Solution: before-tax: 8%. after-tax: 4.8% per year. (b) Would this financing option be good enough to consider if your minimum acceptable rate of return was 10%? (c) Would this financing option be good enough to consider if your minimum acceptable rate of return was 4%? (d) What's the price of the bond at a MARR = 10% per year? Use a before-tax analysis and solve manually (ie., using factor notation). Solution: $829.728.7
4. You need to raise $1,000,000 to buy a dam that will provide energy to your town. Your tax rate is 40%. You would like to finance the transaction by issuing 20-year bonds at a 8% coupon rate, payable annually. (a) What is your before-tax and after-tax cost of money" (taking into account that the coupon payments on the bonds are tax-deductible, but not the repayment of principal in year 20), if the bonds sell for face value? Briefly discuss your results. Solution: before-tax: 8%. after-tax: 4.8% per year. (b) Would this financing option be good enough to consider if your minimum acceptable rate of return was 10%? (c) Would this financing option be good enough to consider if your minimum acceptable rate of return was 4%? (d) What's the price of the bond at a MARR = 10% per year? Use a before-tax analysis and solve manually (ie., using factor notation). Solution: $829.728.7
Chapter1: Federal Income Taxation—an Overview
Section: Chapter Questions
Problem 63P
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Transcribed Image Text:4. You need to raise $1,000,000 to buy a dam that will provide energy to your town. Your tax
rate is 40%. You would like to finance the transaction by issuing 20-year bonds at a 8%
coupon rate, payable annually.
(a) What is your before-tax and after-tax cost of money" (taking into account that the
coupon payments on the bonds are tax-deductible, but not the repayment of principal in year
20), if the bonds sell for face value? Briefly discuss your results. Solution: before-tax: 8%.
after-tax: 4.8% per year.
(b) Would this financing option be good enough to consider if your minimum acceptable
rate of return was 10%?
(c) Would this financing option be good enough to consider if your minimum acceptable
rate of return was 4%?
(d) What's the price of the bond at a MARR = 10% per year? Use a before-tax analysis and
solve manually (ie., using factor notation). Solution: $829.728.7
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