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Madoff Corporation raised money through a bond issue with a total principal value of $3,000,000....

Question:

Madoff Corporation raised money through a bond issue with a total principal value of $3,000,000. Each bond has a face (par) value of $1,000 and a coupon rate of 6%. The company's applicable tax rate is 21%.

a) What is the annual coupon payment bondholders expect to receive?

b) What is total after-tax annual interest expense to the company?

Interest Expense:

Interest expense is a charge against the profits earned by a company during a fiscal period. It is computed by multiplying the face value of the debt with the coupon rate. For a company interest expense acts like a tax shield because it is tax-deductible thereby reducing the tax burden. Interest expense should be paid whether or not a company generates profits leading to high financial risk.

Answer and Explanation:


Answer:

a) The annual coupon payment that is expected by the bondholders to be received is $180,000.

Explanation:

As per the data:

  • Principal value = $3,000,000
  • Coupon rate = 6%
  • Tax rate = 21%

Computation:

  • Annual interest income = Principal value * Coupon rate
  • Annual interest income = $3,000,000 * 6%
  • Annual interest income = $180,000

b) The total after-tax annual interest to the company will be $142,200.

Explanation:

  • After-tax interest expense = Interest expense * (1 - Tax rate)
  • After-tax interest expense = $180,000 * (1 - 0.21)
  • After-tax interest expense = $142,200

Learn more about this topic:

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How to Calculate Interest Expense: Formula & Example

from Financial Accounting: Help and Review

Chapter 5 / Lesson 18
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