Question

What is the after-tax cost of debt for a company with an outstanding bond that makes semi-annual payments with 12 years to maturity, a coupon rate of 9%, a current bond price of $1,117, and a tax rate of 35%?

A. 4.88%

B. 2.44%

C. 7.50%

D. 5.61%

E. 2.62%

Answer 1

Current Price = 1117

Coupon 9%

Maturity = 12 years

Let's assume the YTM be 7%

Value of Bond =

=

= 1160.58367605

Now,

Let's assume the YTM be 8%

Value of Bond =

=

= 1076.23481571

YTM =

= 7% + ((1160.58367605 - 1117) / (1160.58367605 - 1117) + (1117 - 1076.23481571 )) * (8-7)

= 7% + (43.58363705 / (43.58363705) + (40.76518429)) * 1

= 7% + (43.58363705 / 84.34882134) * 1

= 7% + 0.52%

= 7.52%

After tax Cost of Debt = YTM (1- Tax)

= 7.52% (1-0.35)

= 4.88%

Option A is correct.