Question

Coffee and Co. offers 5-year bonds that with a 9 percent semi-annual coupon. The bond currently sells for $919. Their current tax rate is 30%. What is the firms After-Tax Cost of Debt?

	a.	11.16%
	b.	9.39%
	c.	11.20%
	d.	5.58%
	e.	7.81%

Answer 1

Ans: Yeild to Maturity refers total return on bond if bond is held till maturity.

Approx YTM is calculated as below :

Approx. YTM = { Coupon + [ (Face Value - Price ) / n ] } / (Face Value + Price) / 2

To calculate the  Exact YTM will take denominator as [ Face Value * (0.40) + Price * (0.60) ] as below :

YTM = { Coupon + [ (Face Value - Price ) / n ] } / (Face Value * (0.40) + Price * (0.60) )


Computation of Semi-Annual YTM

YTM = { Coupon + [ (Face Value - Price ) / n ] } / (Face Value * (0.40) + Price * (0.60) )
= { 45 + [ (1000 - 919) / 10 ] } / (1000 * 0.4 + 919 * 0.6)
= { 45 + 8.1 } / 951.4
= 53.1 / 951.40
= 0.05581
= ~5.58%


Annual YTM = 2 * Semi- Annual YTM
= 2* 5.58%
= 11.16%

Cost of Debt = 11.16%

After-Tax Cost of Debt = Cost of Debt * (1-Tax Rate)
= 11.16% * (1-30%)
= 7.812%   

Ans : After-tax Cost of Debt = ~7.81%