8. The Excel Corp. is considering issuing $100 million of twenty-year bonds payi

Question

8. The Excel Corp. is considering issuing $100 million of twenty-year bonds paying 5% per year. This is competitive with comparable firms, and it is expected that the bonds will be issued at par. The tax rate is 40%. a. Using the before-tax cash flows and the before-tax interest rate, compute the PV of the debt. b. Using the after-tax cash flows and the after-tax interest rate, compute the PV of the debt. c. Assume that the after-tax cost of capital is .10. Compute the present value of the debt to the firm

Explanation / Answer

a. Before tax interest rate = 10% / (1 - 0.40) = 16.67%

PV of debt = $5 million * PVAF(16.67%, 20 years) + $100 million * PVF(16.67%, 20 years) = $33.20748 millions.

b. After tax cashflow = $5 million * (1 - 0.40) = $3 million.

PV of debt = $3 million * PVAF(10%, 20 years) + $100 million * PVF(10%, 20 years) = $40.40505 millions.

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