Schiffauer Electronics plans to issue 10-year,zero coupon bonds with a par value of $1,000 and a yield to maturity of 9.5%.The company has a tax rate of 30%.How much extra in taxes would the company pay (or save)the second year (at t = 2)if it goes ahead and issues the bonds?
A)$12.59
B)$12.91
C)$13.23
D)$13.56
E)$13.90

Question

Quizplus · Accepted Answer

The correct answer is A.The company would pay $12.59 extra in taxes the second year (at t = 2) if it goes ahead and issues the bonds. This is because the interest expense on the bonds is tax-deductible, so the company would save $12.59 in taxes on the interest expense. However, the company would also have to pay $12.59 in taxes on the imputed interest income on the bonds, which is the difference between the face value of the bonds and the issue price. The net effect is that the company would pay $12.59 extra in taxes the second year.

Schiffauer Electronics Plans to Issue 10-Year,zero Coupon Bonds with a Par