How much will a firm need in cash flow before tax and interest to satisfy debt holders and equity holders if: the tax rate is 35%,there is $13 million in common stock requiring a 10% return,and $6 million in bonds requiring an 6% return?

Question

Quizplus · Accepted Answer

To satisfy both debt holders and equity holders, a firm needs to generate enough cash flow to cover the interest payments on the bonds and provide a return on the common stock.

For the common stock, the firm needs to generate $1.3 million ($13 million x 10%) in returns.

For the bonds, the firm needs to generate $0.36 million ($6 million x 6%) in interest payments.

Total cash flow needed before tax and interest = $1.3 million + $0.36 million = $1.66 million.

To account for the 35% tax rate, we need to divide the cash flow by (1 - 0.35) = 0.65.

So, the total cash flow needed before tax and interest to satisfy debt holders and equity holders is:

$1.66 million / 0.65 = $2.56 million.

Therefore, the answer is C) $2,360,000, which is the closest option to $2.56 million.

How Much Will a Firm Need in Cash Flow Before