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ACCA Strategic Professional · Advanced Financial Management · Financing acquisitions and mergers

Delta plc, a bidder, needs $90 million cash for an acquisition. It can issue new 6% bonds (before tax) or raise equity. Corporate tax is 25%. If the bonds are issued, what is the annual after-tax interest cost?

The annual after-tax interest cost is $4.05 million. Gross interest on $90 million at 6% is $5.40 million, and the 25% tax relief of $1.35 million reduces the net cost to $4.05 million. Adding the shield rather than subtracting it would be incorrect.

  1. A$5.40 million
  2. B$4.05 millionCorrect
  3. C$1.35 million
  4. D$6.75 million

Explanation

Gross interest = $90m x 6% = $5.40m. Tax shield = 25% x $5.40m = $1.35m. After-tax cost = $5.40m - $1.35m = $4.05m. Adding the shield instead gives $6.75m.

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