Question

reuven corp is undergoing a major expansion. the expansion will be financed by issuing new 12-year, $1,000 par, 7% semiannual coupon bonds. The market price of the bond is $940 each. Reuven's floatation expense on the new bonds will be $70 per bond. What is the pre-tax cost of debt for the newly-issued bonds?

Answer 1

Proceeds from bond issue = price-floatation expense

=940-70=870

K = Nx2

Proceeds =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =12x2

870 =∑ [(7*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^12x2

k=1

YTM% = 8.77 = cost of pre tax debt