XYZ Inc. is planning a $200,000 90-day commercial paper issue. The issue is sold for $193,500. There is a flotation cost of $1,500. The corporate tax rate is 35%. (Assume a 365-day year.)

Question

Quizplus · Accepted Answer

Step 1: Calculate the net proceeds from the sale of commercial paper.
Net Proceeds = Issue price - Flotation cost
Net Proceeds = $193,500 - $1,500
Net Proceeds = $192,000

Step 2: Calculate the before-tax cost of commercial paper.
Before-tax cost = (Annual interest expense / Net proceeds) x (360 / Days to maturity)
Before-tax cost = (($200,000 x 0.1571) / $192,000) x (360 / 90)
Before-tax cost = (31,420 / $192,000) x 4
Before-tax cost = 0.1635 or 16.35%

Step 3: Calculate the after-tax cost of commercial paper.
After-tax cost = Before-tax cost x (1 - Tax rate)
After-tax cost = 0.1635 x (1 - 0.35)
After-tax cost = 0.1063 or 10.63%

Therefore, the best choice is B because it is the correct calculation of the before-tax cost. None of the given choices accurately calculate the after-tax cost.

XYZ Inc Is Planning a $200,000 90-Day Commercial Paper Issue