Investment Interest Expense

  

Categories: Bonds

See: Leveraged Buyout. See: Management Buyout.

The purse company was failing. It had once had a prestigious brand among shopping afficionados. But the company grew arrogant. It drew back splits with retailers, and eventually the retailers rebelled. So the company, which used to trade at 12 times cash flow, now trades at 6 times, because its revenues are flat at best. And it is fading in relevance.

Time for the LBO/Private Equity vultures to come around.

The typical structure: they borrow a ton of money, buy the company, fix it, and hope that, when it comes public again, it has much better future prospects than it does today. A huge delimiter in how much that private equity shop can pay for the firm revolves around the interest expense it will incur in borrowing the money, which will then be used to buy the purse company. With half a billion dollars borrowed, even a difference of 1% comprises a cost difference of 5 million bucks a year. So the IIE is a big fat hairy deal when bidders do their calculations for what they can or can not pay.

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Finance: What is Imputed Interest Rate?1 Views

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Finance allah shmoop What is imputed interest rate Imputed guest

00:09

at or presumed based on x y and z that's

00:13

the foundation of an imputed interest rate and its chief

00:16

cheerleader Yep It's the i r s the tax people

00:20

those guys you just love to hear from Why Well

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because taxes need to be collected Right We have pork

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to buy for politicians Come on people Get with it

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So we have a zero coupon bond here We bought

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for five hundred bucks which comes do or pays off

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in ten years for a thousand dollars on lee Remember

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Zero coupon bonds don't pay any interest along the way

00:41

They just pay a one time end of period amount

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which includes interest and principal The irs taxes Bondholders imputed

00:51

interest Yes like gains based on whatever interest rate is

00:55

imputed by the terms of the deal So in this

00:59

case remember that rule of seventy two thing so many

01:02

years to doubled about it into seventy two and all

01:04

that Yeah So in this case the money takes ten

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years to double that's ten into seventy two paying seven

01:10

point two percent interest per year Compound it So the

01:15

irs would take as an imputed interest Five hundred box

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times seven point two which is thirty six dollars of

01:23

taxable imputed interest games And they would take that each

01:27

year and you'd pay that each year on your taxes

01:29

So if you owned this bond and we're living in

01:32

a forty percent marginal tax bracket blue state which you

01:35

livin bitterly even though you got no cash interest from

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this bond will you'd suffer a cash tax hit of

01:43

forty percent of thirty six or a bit under fifteen

01:46

dollars each year as you went along So that's the

01:49

bad news you pay the cash up front The good

01:51

news is that when the bond finally came do that

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decade later for that grand well you have already paid

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the taxes along the way And when taxes are already 00:02:01.504 --> [endTime] paid well we impute you'll be a happier camper

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