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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881

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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881
Textbook Problem
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Brief ExerciseCost of Debt Financing

Crackle Company instituted an aggressive plan to lower its cost of financing over the next decade. Currently Crackle’s cost of debt financing is 8%, its cost of equity financing is 14%, and its tax rate is 35%. Crackle currently has $2,500,000 of debt.

Required:

  1. Calculate the after-tax cost amount of interest expense.
  2. How does the tax effect of interest expense affect financial leverage?

To determine

Concept introduction:

Bonds:

Bonds are debt instruments issued by the borrower company to its lenders. Bonds are issued at a specified rate of interest and for a specified time period. The bondholders get a fixed rate of interest on the bonds and repayment of the bonds at the maturity date.

Requirement 1:

To calculate:

The After tax cost amount of interest expense.

Explanation

The after tax cost amount of interest expense is calculated as follows:

After tax cost of de...

To determine

Concept introduction:

Bonds:

Bonds are debt instruments issued by the borrower company to its lenders. Bonds are issued at a specified rate of interest and for a specified time period. The bondholders get a fixed rate of interest on the bonds and repayment of the bonds at the maturity date.

Requirement 2:

To indicate:

The effect of tax on interest expense and financial leverage.

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