Question

Coneheads Haberdashery plans to issue a new bond with a coupon rate of interest equal to the yield of its existing bond, which was issued five years ago. The existing bond has a coupon rate of interest equal to 8 percent, 15 years remaining until maturity, an face value equal to $1,000. Interest is paid semiannually. The market value of the existing bond is $1,196. What is Coneheads' before-tax of debt? Coneheads' marginal tax rate is 35 percent.

a. 6.69%

b. 6.00%

c. 8.00%

d. 5.98%

e. 3.00%

Answer 1

Given about Coneheads Haberdashery's current bond,

Face value = $1000

coupon rate = 8% paid semiannually,

So, semiannual coupon payment = (8%/2) of 1000 = $40

years to maturity = 15

current price = $1196

Bonds' Yield can be calculated on financial calculator using following values:

FV = 1000

PV = -1196

N = 2*15 = 30

PMT = 40

Compute for I/Y, we get I/Y = 3.00

=> YTM of the bond = 2*3 = 6%

For a company, its before-tax cost of debt equals to its bond's YTM

So, company's before-tax cost of debt = 6%

Option b is correct.