The Goodsmith Charitable foundation, which is tax-exempt, issued debt last year

Question

The Goodsmith Charitable foundation, which is tax-exempt, issued debt last year at 9 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 25% higher; that is, firms that paid 11 percent for debt last year will be paying 13.75 percent this year.

a) if the goodsmith foundation borrowed money this year, what would the after tax cost of debt be, based on its cost last year and the 25% increase?

b) if the receipts of the foundation were found to be taxable by the IRS (at a rate of 34% because of the involvement in political activities), what would the aftertax cost of the debt be?

Explanation / Answer

a debt cost this year (9*1.25) 11.25% tax 0 after tax cost 11.25% (as income is tax exempt so no tax benefit on cost) b debt cost this year (9*1.25) 11.25% tax 34% after tax cost (11.25*(1-0.34)) 7.43%

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