The cash flow plan associated with a debt financing transaction allowed a company to receive $2,800,000 now in lieu of future interest payments of $196,000 per year for 10 years plus a lump sum of $2,800,000 in year 10. If the company’s effective tax rate is 33%, determine its cost of debt capital (a) before taxes, and (b) after taxes.
What will be an ideal response?
(a) 0 = 2,800,000 – 196,000(P/A,i*,10) – 2,800,000(P/F,i*,10)
i* = 7.0% (RATE function)
Before-tax cost of debt capital is 7.0% per year
(b) NCF is determined using Equation [10.6]
NCF = 196,000(1 - 0.33) = $131,320
0 = 2,800,000 - (131,320)(P/A,i*,10) - 2,800,000
i* = 4.69% (RATE function)
After-tax cost of debt capital is 4.69% per year
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