A company is planning to raise $1,000,000 to finance a new plant.Which of the following statements is correct?
A) If debt is used to raise the million dollars,the cost of the debt would be lower if the debt is in the form of a fixed rate bond rather than a floating rate bond.
B) If debt is used to raise the million dollars,the cost of the debt would be lower if the debt is in the form of a bond rather than a term loan.
C) If debt is used to raise the million dollars,but $500,000 is raised as a first mortgage bond on the new plant and $500,000 as debentures,the interest rate on the first mortgage bond would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds.
D) The company would be especially anxious to have a call provision included in the indenture if its management thinks that interest rates are almost certain to rise in the foreseeable future.
E) All of the above statements are false.

Question

Quizplus · Accepted Answer

This statement is correct because by raising only half of the required funds through first mortgage bonds, the risk to investors is reduced, making the interest rate on the first mortgage bond lower than if the entire amount were raised using only first mortgage bonds. A diversification of financing methods is generally more appealing to investors. The other statements are false. The cost of debt does not depend on the form of bonds but on the prevailing market interest rates, and a term loan may be cheaper than a bond. A call provision may increase the cost of debt by allowing the company to call back the bond prematurely and refinance it at higher rates.

A Company Is Planning to Raise $1,000,000 to Finance a New