Interest Rate Tax Deductions: Example 
PanterSkill Corporation is deciding between issuing two different bonds. They can either issue a zero-coupon, 30-year bond, with a YTM of 7.75% (Bond "A"), or, a 30-year, 20%-coupon bond, with a YTM of 8.125% (Bond "B"). Both bonds have a $1,000 face value.


What are the prices that an investor would be willing to pay for these bonds?

  If the firm wants to raise approximately $100,000 and wants to either issue 940 bonds "A", or 83 bonds "B", what are the total annual explicit interest expenses for the firm?

  If PanterSkill issues the 940 zero-coupon bonds ("A"), what is the total implicit interest being paid over the 30 years?

If PanterSkill, instead, issues the 83 bonds "B", what is the total interest being paid over the 30 years?

If the corporate tax rate is 35%, and the tax law allows PanterSkill to take the interest rate deduction on the implicit interest only at the end of the 30 years (the firm can take regular annual deductions on explicit interest payments), what is the present value of the tax deductions for both bonds if the firm's EBIT  is $1 million per year, and the appropriate discount rate is 9%? (Hint: the EBIT of $1 million per year is really irrelevant, what matters is how much the firm can save each year on its tax bill based on interest rate deductions).

All else equal, which of the two bonds ("A" or "B"), based on your previous answer, is more attractive to PanterSkill and why?



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