Question

The debt position of a company is: 15,000 7 percent coupon bond outstanding, 15 years to maturity, selling for 92 percent of par; the bonds have a $1,000 par value each and make semiannual payments. The tax rate is 35 percent. The after tax cost of debt is:

.0396

.0792

  .0515

.0700

None of the above

Answer 1

Price of bond = 92% of 1000 = $920

Face value = $1000

Coupon = 0.07 * 1000 = 70 / 2 = $35 ( since it is a semi annual bond, we divide by 2)

N = 15 * 2 = 30

Before tax cost of debt = ?

Before tax cost of debt using a financial calculator is 7.92084

Keys to use in a financial calculator: FV = 1000, PV = -920, PMT = 35, N = 30, CPT I/Y

When you click on CPT I/Y, you get 3.96042%. to annualize this return, we multiply by 2, 3.96042 * 2 = 7.9208%)

After tax cost of debt = 0.079208 ( 1 - 0.35 )

After tax cost of debt = 0.0515