Buchanan Corp. is refunding $10 million worth of 10% debt. The new bonds will be issued for 8%. The corporation's tax rate is 35%. The call premium is 9%. What is the net cost of the call premium?

Question

Quizplus · Accepted Answer

To calculate the net cost of the call premium, we need to add the premium cost to the loss of interest income and then reduce it by the tax savings.

Premium cost = 9% × $10,000,000 = $900,000 
Loss of interest income = 10% - 8% = 2% × $10,000,000 = $200,000 
Tax savings = 35% × ($900,000 - $200,000) = $245,000

Therefore, the net cost of the call premium is: 
$900,000 - $200,000 - $245,000 = $455,000

The closest option to this calculated value is C ($585,000), hence it is the correct answer.