Question

Bond Yield and After-Tax Cost of Debt

A company's 7% coupon rate, semiannual payment, $1,000 par value bond that matures in 25 years sells at a price of $747.72. The company's federal-plus-state tax rate is 35%. What is the firm's after-tax component cost of debt for purposes of calculating the WACC? (Hint: Base your answer on the nominal rate.) Round your answer to two decimal places.

%

Answer 1

Solution

Current price of bond=Present value of coupon payments+Present value of face value

Current price of bond=Coupon payment*((1-(1/(1+r)^n))/r)+Face value/(1+r)^n

where

n=number of periods=25*2=50

r-discount rate per period

Face value =1000

Semi annual coupon=Coupon rate/2*Face value=7%/2*1000=35

Curent price=747.72

747.72=35*((1-(1/(1+r)^50))/r)+1000/(1+r)^50

Solving we get r=.0485=4.85%

Therefore the YTM=Before tax cost of debt=r*2=4.85*2=9.7%

After tax cost of debt =Before tax cost of debt*(1-tax rate)=9.7*(1-.35)=6.3050

Thus firms After tax cost of debt=6.31%

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answered by: anonymous