Question

Micro Spinoffs, Inc., issued 20-year debt a year ago at par value with a coupon rate of 8%, paid annually. Today, the debt is selling at $1,100. If the firm’s tax bracket is 20%, what is its after-tax cost of debt? Assume a face value of $1,000.

Please do not copy from Chegg. Only attempt if you are sure about the answer. Solve in a step by step manner, explaining each step.

Answer 1

Answer : Calculation of After Tax Cost of Debt :

After Tax Cost of Debt can be calculated using Rate Function of Excel ;

=RATE(nper,pmt,pv,fv)

where'nper is the number of years to maturity remaining i.e 19 years (20 - 1)

Note : As the Bond is issued a year ago therefore years remainig to maturity is 19.

pmt is the periodic coupon payment i.e 1000 * 8% = 80

pv is the Current Price of the Bond i.e 1100

Note : while calculating Pv figure should be taken as negative.

fv is the Face value of Bond i.e 1000

=RATE(19,80,-1100,1000)

Therefore This function will give you exact Before Tax Cost of Debt

On Solving

Before Tax Cost of Debt = 7.03%

After Tax Cost of Debt = Before Tax Cost of Debt * (1 - Tax Rate)

= 7.03% * (1 - 0.20)

= 5.62%