Question

Suppose you are trying to estimate the after tax cost of debt for a firm as part of the calculation of the Weighted Average Cost of Capital (WACC). The corporate tax rate for this firm is 37%. The firm's bonds pay interest semiannually with a 5.7% coupon rate and have a maturity of 6 years. If the current price of the bonds is $932.56, what is the after tax cost of debt for this firm? (Answer to the nearest tenth of a percent, e.g. 12.3%, but do not use a percent sign).

Answer 1

After tax cost of debt = 4.5%

Using financial calculator BA II Plus - Input details:	#
FV = Future Value / Face Value =	-$1,000.00
PV = Present Value =	$932.56
N = Number of years remaining x frequency = 6 x 2 =	12
PMT = Payment = Coupon / frequency = 5.7%/2 x 1000 =	-$28.50
CPT > I/Y = Rate per period or YTM per period =	3.5499
Convert Yield in annual and percentage form = Yield*frequency / 100 =	7.100%
After tax Cost of debt = YTM x (1-Tax) = 7.100% x (1-37%) =	4.5%