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 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:
a) The annual coupon payment that is expected by the bondholders to be received is $180,000.
As per the data:
- Principal value = $3,000,000
- Coupon rate = 6%
- Tax rate = 21%
- 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.
- After-tax interest expense = Interest expense * (1 - Tax rate)
- After-tax interest expense = $180,000 * (1 - 0.21)
- After-tax interest expense = $142,200
Become a member and unlock all Study Answers
Try it risk-free for 30 daysTry it risk-free
Ask a question
Our experts can answer your tough homework and study questions.Ask a question Ask a question
Learn more about this topic:
from Financial Accounting: Help and ReviewChapter 5 / Lesson 18