Question

Avicorp has a

$10.6

million debt issue​ outstanding, with a

5.9%

coupon rate. The debt has​ semi-annual coupons, the next coupon is due in six​ months, and the debt matures in five years. It is currently priced at

95%

of par value.

a. What is​ Avicorp's pre-tax cost of​ debt? Note: Compute the effective annual return.

b. If Avicorp faces a

40%

tax​ rate, what is its​ after-tax cost of​ debt?

​Note: Assume that the firm will always be able to utilize its full interest tax shield.

a. The cost of debt is

nothing​%

per year.  ​(Round to four decimal​ places.)

Answer 1

Answer a.

Face Value = $10,600,000

Current Price = 95% * $10,600,000
Current Price = $10,070,000

Annual Coupon Rate = 5.90%
Semiannual Coupon Rate = 2.95%
Semiannual Coupon = 2.95% * $10,600,000
Semiannual Coupon = $312,700

Time to Maturity = 5 years
Semiannual Period to Maturity = 10

Let Semiannual YTM be i%

$10,070,000 = $312,700 * PVIFA(i%, 10) + $10,600,000 * PVIF(i%, 10)

Using financial calculator:
N = 10
PV = -10070000
PMT = 312700
FV = 10600000

I = 3.5528%

Semiannual YTM = 3.5528%

Before-tax Cost of Debt = (1 + Semiannual YTM)^2 – 1
Before-tax Cost of Debt = (1 + 0.035528)^2 - 1
Before-tax Cost of Debt = 1.072318 - 1
Before-tax Cost of Debt = 0.072318 or 7.2318%

Answer b.

After-tax Cost of Debt = Before-tax Cost of Debt * (1 - Tax Rate)
After-tax Cost of Debt = 7.2318% * (1 - 0.40)
After-tax Cost of Debt = 4.3391%

answered by: anonymous