In September of 1995, McDonalds Corporation issued $150 millionof Senior Notes due in 2005. The notes were issued at par and boreinterest of 6 5/8%. The debt was rated AA by Moodys. Interestpayments on this debt were deductible for corporate tax purposes(you may assume that McDonalds’s marginal corporate tax rate was35%), though principal repayments were not. All principal would berepaid in September 2005.
A. From McDonalds’s perspective, what is theeffective after-tax cost of this debt (expressed as an annualpercentage)?
B. How many dollars of taxes will McDonaldssave each year through the deduction of the interest expense onthese notes from taxable income (you may assume that McDonalds willhave sufficient taxable income in future years to cover theinterest expense on this debt)? What is the present value of thesefuture tax savings?
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