• Crandal Dockworks is undergoing a major expansion. The expansion will be financed by issuing new 15-year, $1,000 par, 10% semi-annual coupon bonds. The market price of the bonds is $1,090 each. Crandal's flotation expense on the new bonds will be $40 per bond. Crandal's marginal tax rate is 25%. What is the After-Tax cost of debt for the newly-issued bonds?
A) 6.68% B) 7.03% C) 7.21% D) 7.54%
B is the correct answer, please show how you arrive at that answer
Given about Crandal Dockworks' bond,
years to maturity = 15 years
Face value = $1000
coupon rate = 10% paid semiannually
So, semiannual coupon =(10%/2) of 1000 = $50
current market price = $1090
Flotation cost = $40
So, adjusted price after flotation cost = price - flotation cost = 1090 - 40 = $1050
YTM of the bond is calculated on financial calculator using following values:
FV = 1000
PMT = 50
N = 2*15 = 30
PV = -1050
Compute for I/Y, we get I/Y = 4.686
So, YTM of the bond = 2*4.686 = 9.37%
for a company, its before tax cost of debt equals its bond's YTM
=> Kd = 9.37%
tax rate T = 25%
So, after tax cost of debt = Kd*(1-T) = 9.37*(1-0.25) = 7.03%
So, option B is correct.
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