Question

Consider the following scenario: ABC company pays federal income taxes at a rate of 35% on taxable income.

Write a 200- to 350-word paper in APA format in which you complete the following:

1.) Briefly explain the income tax advantage of raising capital by issuing bonds rather than selling capital stock.

2.) Compute the company’s annual after-tax cost of borrowing on an 8%, $5 million bond issue.

3.) Express this after-tax cost as a percentage of the borrowed $5 million. Include your calculations.

Include your calculations.

Can you please help me with just answering the questions and the calculations, and i will format the paper? Thank you!!

Answer 1

1. When we issue Bonds the interest paid on such bonds is allowed as an expense for income tax purposes. However in case of capital stock the dividend paid is not allowed as an expense for income tax purpose. Therefore if a company pays interest as the expense is allowable for income tax purpose it helps in reducing tax to the extent of tax rate for such amount. However in case of capital stock it does not happen.So if the company tax rate is 35% and cost of borrowing is 8%. The effective cost of borrowing is 8*(1-0.35) which comes to 5.2%.

2. Annual after tax cost of borrowing = 5.2%*$5million = $260,000.

3. After tax cost as a percentage is 5.2% (8*(1-0.35)).