Question

Your firm has just issued a 20-year $1,000.00 par value, 10% annual coupon bond for a net price of $964.00. What is the cost of debt that should be used when computing the Weighted Average Cost of Capital? The firm is in the 25% tax bracket.

Answer 1

Given about a firm's bond,

Year to maturity = 20 years

Face value = $1000

Price = $964

coupon rate = 10% paid annual.

So, annual coupon payment = 10% of 1000 = $100

So, YTM of the bond can be calculated on financial calculator using following values:

FV = 1000

PMT = 100

PV = -964

N = 20

Compute for I/Y, we get I/Y = 10.44

For a firm its Pretax Cost of debt equals its bond's YTM,

So, Pretax cost of debt for the firm Kd = 10.44%

Tax rate = 25%

So, after-tax cost of debt = Kd*(1-T) = 10.44*(1-0.25) = 7.83%