The Telescoping Tube Company is planning to raise $2,500,000 in perpetual debt at 11% to finance part of their expansion. They have just received an offer from the Albanic County Board of Commissioners to raise the financing for them at 8% if they build in Albanic County. What is the total added value of debt financing to Telescoping Tube if their tax rate is 34% and Albanic raises it for them?

Question

Quizplus · Accepted Answer

The added value of debt financing is the difference between the interest cost of the two options (11% and 8%), adjusted for taxes. The after-tax cost of the 11% debt is 0.66 x 11% = 7.26%. The after-tax cost of the 8% debt is 0.66 x 8% = 5.28%. Therefore, the added value of debt financing is (11% - 8%) x $2,500,000 x (1 - 0.34) = $1,300,000.

The Telescoping Tube Company Is Planning to Raise $2,500,000 in Perpetual