A firm wants to finance an investment that would produce anannual EBIT of $415,000 by issuing 850 ten-year zero-coupon bonds(each with $1,000 face value) that will be charged a marketinterest rate of 8%. Suppose the bonds will be issued on January 1,2020 and will mature on December 31, 2029.
Assume EBIT is constant over time at $415,000 and the tax rateis 35%. Shown below are income statement templates for the years2020 and 2029. You do not have to fill these in for credit on theexam, however, feel free to use them as guides for determining howthe choice of financing will affect the firm's tax liability forthese years. Specifically, determine
a) How much the firm saves in taxes in 2020 and how much thefirm saves in taxes in 2029 by having this 10-year bond on itsbooks (relative to the case without any borrowing)? (Don't worryabout discounting these tax savings back to the present, justconsider the nominal dollar amounts.)
b) How much the firm saves in taxes in 2020 and 2029 inpresent value terms by having this 10-year bond on its books(again, relative to the case without any borrowing). Assume thatJanuary 1, 2020 is the \"present,\" the discount rate is 8%, and thetaxes would be paid on December 31 of the statement year.
Income statement for 2020 (Jan 1 - Dec 31,2020)
| With the bond | Without the bond |
| EBIT | $415,000.00 | $415,000.00 |
| Interest | | |
| Pre-tax Income | | |
| Taxes at 35% | | |
| Net Income | | |
Income statement for 2029 (Jan 1 - Dec 31,2029)
| With the bond | Without the bond |
| EBIT | $415,000.00 | $415,000.00 |
| Interest | | |
| Pre-tax Income | | |
| Taxes at 35% | | |
| Net Income | |
