Question

Question 5.5. Wentworth Industries sold a 15 year $1,000 face value bond with a 10.5 percent coupon rate. Interest is paid annually. After flotation costs, Wentworth received $920 per bond. Compute the after-tax cost of debt for these bonds if the firm's marginal tax rate is 28 percent. (Points : 3.4)

       5.49%
       7.62%
       8.40%
       11.65%

Answer 1

The correct answer is 8.40%

Note:

The Approximate Yield to Maturity Formula =[Coupon + ( Face Value - Market Price) / Number of years to maturity] / [( Face Value + Market Price)/2 ] *100

= [$ 105+ ( $ 1,000- $ 920) / 15] /[( $ 1,000+ $920)/2] *100

= 110.3333 / 960 *100

= 11.49305552%

Note : Coupon = Rate * Face Value

= 10.5% * $ 1,000

= $ 105

Since this formula gives an approximate value, the financial calculators can be used alternatively.

where,

Par Value = $ 1,000

Market Price = $ 920

Annual rate = 10.5% and

Maturity in Years = 15 Years

Hence the yield to maturity =11.65%

Now, the after tax cost of debt = Yield to Maturity * (1- tax Rate)

= 11.65% * ( 1-28%)

= 8.388%

The answer is rounded off.