Question

Costly Corporation plans a new issue of bonds with a par value of $1000, a maturity of 30 years, and an annual coupon rate of 13.0%. Flotation costs associated with a new debt issue would equal 8.0% of the market value of the bonds. Currently, the appropriate discount rate for bonds of firms similar to Costly is 17.0%. The firm's marginal tax rate is 30%. What will the firm's true cost of debt be for this new bond issue?

18.48%

12.93%

14.17%

9.92%

20.75%

Answer 1

Use below excel formula

RATE(nper,pmt,pv,fv,type,guess)

Nper   is the total number of payment periods in an annuity.

Pmt   is the payment made each period and cannot change over the life of the annuity. Typically, pmt includes principal and interest but no other fees or taxes. If pmt is omitted, you must include the fv argument.

Pv   is the present value — the total amount that a series of future payments is worth now.

Fv   is the future value, or a cash balance you want to attain after the last payment is made. If fv is omitted, it is assumed to be 0

=RATE(30,130,-920,1000)

Nper = 30 years

Payment = 13% of 1000 = 130

PV = (1000-80) = 920; since 8% is flotation cost so 8% of 1000 is 80

FV = 1000

Before tax cost will be 14.15%

After tax cost = 14.15% * (1-30%) = 14.15% * 0.7 = 9.92% .......Answer