Charter Corp. has issued 2,792 debentures with a total principal value of $2,792
ID: 2813281 • Letter: C
Question
Charter Corp. has issued 2,792 debentures with a total principal value of $2,792,000 . The bonds have a coupon interest rate of 9 %.
a. What dollar amount of interest per bond can an investor expect to receive each year from Charter? (dont answer this)
b. What is Charter's total interest expense per year associated with this bond issue?(dont answer this)
c. Assuming that Charter is in a 34 % corporate tax bracket, what is the company's net after-tax interest cost associated with this bond issue?
What is question c asking ? Or what is net after tax interest cost associated with the bond issue ? Can you please explain this in simple terms. (For instance, is this cash the company has to pay out or is it what the bond holders pay on their interest) Thank you
Explanation / Answer
Net After-Tax Interest Cost
It is nothing but the interest cost after tax. Let me take the current example,
In this case, Charter Corp. has issued 2,792 debentures with a total principal value of $2,792,000 which have a coupon interest rate of 9 %. So comany need to pay $251,280 ($2,792,000*9%) per annum to its debenture holders as interest. But as you know debenture interest is a tax deductible expenses. Hence the comapny will save tax to the extend of $85,435.20(251280*34%). So the actual interest cost to company = interest paid to debenture holders - tax sasved on interest expenses=251280-85435.2=$165,844.80
It can be directly calculated as
Debt * interest % * (1-tax rate)