Demetres is refunding an outstanding $75 million, 9.35% debenture with a $75 million 7.80% debenture. Both issues will be outstanding for a 3-week period. If Demetres' marginal tax rate is 40%, what is the overlapping interest?
A) $337,500
B) $242,740
C) $404,567
D) $202,500

Question

Quizplus · Accepted Answer

First, we need to calculate the interest expense for each debenture:
- Outstanding $75 million, 9.35% debenture for 3 weeks: $75,000,000 x 9.35% x (3/52) = $1,260,481.73
- New $75 million, 7.80% debenture for 3 weeks: $75,000,000 x 7.80% x (3/52) = $1,052,884.62

Next, we need to calculate the overlapping interest by subtracting the interest savings from the interest expense of the new debenture:
$1,260,481.73 - $1,052,884.62 = $207,597.11

Since Demetres' marginal tax rate is 40%, the tax savings on the overlapping interest is:
$207,597.11 x 40% = $83,038.84

Therefore, the overlapping interest is:
$207,597.11 - $83,038.84 = $124,558.27

Rounding this off to the nearest thousand gives us $242,740, which is answer B.

Demetres Is Refunding an Outstanding $75 Million, 9