Tri-States Gas Producers expects to borrow $800,000 for field engineering improvements. Two methods of debt financing are

Question:

Tri-States Gas Producers expects to borrow $800,000 for field engineering improvements. Two methods of debt financing are possible-borrow it all from a bank or issue debenture bonds. The company will pay an effective 8% per year to the bank for 8 years. The principal on the loan will be reduced uniformly over the 8 years, with the remainder of each annual payment going toward interest. The bond issue will be for 800 10-year bonds of $1000 each that require a 6% per year dividend payment.

(a) Which method of financing is cheaper after an effective tax rate of 40% is considered?

(b) Which is the cheaper method using a before tax analysis?

Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their...