Debt capital from a tax perspective

Bristol Myers Squibb, an international pharmaceutical company, is initiating a new project for which it requires $2.5 million in debt capital. The current plan is to sell20-year bonds that pay 4.2% per year, payable quarterly, at a 3% discount on the face value. BMS has an effective tax rate of 35% per year.

Determine (a) the total face value of the bonds required to obtain $2.5 million and (b) the effective annual after-tax cost of debt capital.

To understand the advantage of debt capital from a tax perspective in the United States, determine the before-tax and after-tax weighted average costs of capital if a project is funded 40%-60% with debt capital borrowed at 9% per year. A recent study indicates that corporate equity funds earn 12% per year and that the effective tax rate is 35% for the year.

Solution:

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