Question

If a corporation issued $4,000,000 in bonds which pay 10% annual interest, what is the annual net cash cost of this borrowing if the income tax rate is 30%?

A) $4,000,000
B) $120,000
C) $400,000
D) $280,000

Answer 1

The annual net cash cost of borrowing $4,000,000 at 10% interest with a 30% income tax rate is $280,000, after accounting for tax savings on the interest expense.

Step-by-step explanation:

If a corporation issued $4,000,000 in bonds which pay 10% annual interest, the annual interest cost before taxes would be $400,000 (which is 10% of $4,000,000). However, since interest expense is tax-deductible, the company can save a portion of this expense through tax savings. To calculate the net cash cost of the borrowing after the effect of a 30% income tax rate, we multiply the interest cost by (1 - tax rate). Therefore, the net cash cost is $400,000 x (1 - 0.30) = $280,000. Thus, the correct answer is D) $280,000.