Question

Galvatron Metals has a bond outstanding with a coupon rate of 6 percent and semiannual payments. The bond currently sells for $1,940 and matures in 20 years. The par value is $2,000 and the company's tax rate is 39 percent. What is the company's aftertax cost of debt?

Answer 1

Information provided:

Par value= future value= $2,000

Current price= present value= $1,940

Time= 20 years*2= 40 semi-annual periods

Coupon rate= 6%/2= 3% per semi-annual period

Coupon payment= 0.03*$2,000= $60

Tax rate= 39%

The after tax cost of debt is calculated by first computing the before tax cost of debt. The before tax cost of debt is calculated by computing the yield to maturity.

The yield to maturity is calculated by entering the below in a financial calculator:

FV= 2,000

PV= -1,940

N= 40

PMT= 60

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 3.1326.

Therefore, the yield to maturity is 3.1326%*2= 6.2652%

After tax cost of debt= before tax cost of debt*(1- tax rate)

= 6.2652%*(1 - 0.39)

= 3.8218% 3.82%.