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

Question

Quizplus · Accepted Answer

The annual interest expense is $400,000 (10% of $4,000,000). However, since the corporation can deduct this interest expense on their taxes, their net cash cost will be reduced by the tax savings. The tax savings will be 30% of the interest expense which is $120,000 ($400,000 x 0.30). Therefore, the annual net cash cost is $280,000 ($400,000 - $120,000).

If a Corporation Issued $4,000,000 in Bonds Which Pay 10