A company that makes several different types of skateboards, Jennings Outdoors, incurred interest expenses of $1,200,000 per year from various types of debt financing. The company received $19,000,000 in year 0 through the sale of discounted bonds with a face value of $20,000,000. The company repaid the principal of the loans in year 15 in a lump sum payment of $20,000,000. If the company’s effective tax rate is 29%, what was Jennings’ cost of debt capital (a) before taxes, and (b) after taxes? (c) Write a single-cell RATE function to display the rate for each debt capital cost requested.
What will be an ideal response?
(a) 0 = 19,000,000 – 1,200,000(P/A,i*,15) – 20,000,000(P/F,i*,15)
i* = 6.53% (spreadsheet)
Before-tax cost of debt capital is 6.53% per year
(b) Tax savings = 1,200,000(0.29) = $348,000
NCF = 1,200,000 - 348,000 = $852,000
0 = 19,000,000 - 852,000(P/A,i*,15) – 20,000,000
i* = 4.73% (spreadsheet)
After-tax cost of debt capital is 4.73% per year
(c) Before taxes: = RATE(15,-1200000,19000000,-20000000) displays 6.53%
After taxes: = RATE(15,-1200000*(1-0.29),19000000,-20000000) displays 4.73%
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