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 40%, there is $10 million in common stock requiring a 12% return, and $6 million in bonds requiring an 8% return?

Question

Quizplus · Accepted Answer

To calculate the required cash flow before tax and interest, we need to find the total amount of return required by both debt holders and equity holders.

For bonds, the return required is $6 million x 8% = $480,000

For common stock, the return required is $10 million x 12% = $1,200,000

Total return required = $480,000 + $1,200,000 = $1,680,000

However, this is before tax and interest. If we apply the tax rate of 40%, we get:

Required cash flow before tax and interest = $1,680,000 / (1 - 0.4) = $2,800,000

How Much Will a Firm Need in Cash Flow Before