Question

Company B issued an 8 percent coupon semiannual bond that matures in 25 years. Face value of the bond is $1,000. The bond currently sells for 90 percent of its face value. What is the after-tax cost of debt if the company's tax rate is 36 percent?

5.63 percent

5.85 percent

5.92 percent

4.50 percent

5.77 percent

Answer 1

Yield to maturity is the total return on bond if the bond is held in maturity.

Price = 90% of Face Value = 900
Semi-annual coupon = 1000 * 8% / 2 = 40
n = number of periods = 25 yrs * 2 = 50

It is Calculated as below :

Semi Annual YTM = { Coupon + [ (Face Value - Price) / t ] } / ( Face Value (0.40) + Price * (0.6) )
  = { 40 + [ (1000 - 900) / 50 ] } / (1000 * 0.40 + 900 * 0.60 )
= 42 / 940
   = 0.04468


Annual YTM = 4.468% * 2 = 8.93%

Cost of Debt = 8.93%
After tax Cost of Debt = 8.93% * (1 - 36%) = 5.7%

Ans : After tax Cost of Debt = 5.77%