Tri-States Gas Producers expects to borrow $800,000 for field engineering improvements. Two methods of debt financing are possible—borrow it all from a bank or issue debenture bonds. The company will pay an effective 8% per year to the bank for 8 years. The principal on the loan will be reduced uniformly over the 8 years, with the remainder of each annual payment going toward interest. The bond issue will be for 800 ten-year bonds of $1000 each that require a 6% per year dividend payment. (a) Which method of financing is cheaper after an effective tax rate of 40% is considered? (b) Which is the cheaper method using a before-tax analysis? Is it the same as the after-tax choice?
Tri-States Gas Producers expects to borrow $800,000 for field engineering improvements. Two methods of debt financing are possible—borrow it all from a bank or issue debenture bonds. The company will pay an effective 8% per year to the bank for 8 years. The principal on the loan will be reduced uniformly over the 8 years, with the remainder of each annual payment going toward interest. The bond issue will be for 800 ten-year bonds of $1000 each that require a 6% per year dividend payment. (a) Which method of financing is cheaper after an effective tax rate of 40% is considered? (b) Which is the cheaper method using a before-tax analysis? Is it the same as the after-tax choice?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Tri-States Gas Producers expects to borrow
$800,000 for field engineering improvements. Two
methods of debt financing are possible—borrow it
all from a bank or issue debenture bonds. The company
will pay an effective 8% per year to the bank
for 8 years. The principal on the loan will be reduced uniformly over the 8 years, with the remainder of
each annual payment going toward interest. The
bond issue will be for 800 ten-year bonds of $1000
each that require a 6% per year dividend payment.
(a) Which method of financing is cheaper after
an effective tax rate of 40% is considered?
(b) Which is the cheaper method using a before-tax
analysis? Is it the same as the after-tax choice?
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