The Goodsmith Charitable foundation, which is tax-exempt, issued debt last year

Question

The Goodsmith Charitable foundation, which is tax-exempt, issued debt last year at 8 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 20% higher; that is, firms that paid 10 percent for debt last year will be paying 12 percent this year. a) if the goodsmith foundation borrowed money this year, what would the after tax cost of debt be, based on its cost last year and the 20% increase? b) if the receipts of the foundation were found to be taxable by the IRS (at a rate of 35% because of the involvement in political activities), what would the aftertax cost of the debt be?

Explanation / Answer

The Goodsmith Charitable Foundation, which is tax-exempt, issued debt last year at 8 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 20 percent higher; that is, firms that paid 10 percent for debt last year would be paying 12 percent this year.

a.   If the Goodsmith Charitable Foundation borrowed money this year, what would the aftertax cost of debt be, based on their cost last year and the 20 percent increase?

Kd = Yield (1 – T)

Yield = 8% * 1.20 = 9.6%

Kd = 9.6% (1 – 0) = 9.6% (1) = 9.6%

b. If the Foundation was found to be taxable by the IRS (at a rate of 35 percent) because it was involved in political activities, what would the aftertax cost of debt be?

Kd = 9.6% (1 – .35) = 9.6% (.65) = 6.24%

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