Gargoyle Unlimited
Gargoyle Unlimited is planning to issue a zero coupon bond to fund a project that will yield its first positive cash flow in three years.That cash flow will be sufficient to pay off the entire debt issue.The bond's par value will be R1,000, it will mature in 3 years, and it will sell in the market for R727.25.The firm's marginal tax rate is 40 percent.
-Refer to Gargoyle Unlimited.What is the rand value of the interest tax savings to the firm in the third year of the issue?

Question

Quizplus · Accepted Answer

Since the bond is a zero coupon bond, it does not pay any interest over its 3-year life. Therefore, the interest tax savings to the firm in the third year will be equal to the amount of the bond's face value (R1,000) multiplied by the firm's marginal tax rate (40 percent), which equals R400. However, since the cash flow from the project will be sufficient to pay off the entire debt issue, the firm will not have any interest tax savings in the first two years. Therefore, the interest tax savings in the third year is the only relevant value, which is R400. Since the question asks for the rand value, we do not need to discount this amount back to present value. Therefore, the answer is B) R40.29.

Gargoyle Unlimited Gargoyle Unlimited Is Planning to Issue a Zero Coupon Bond