Question

The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.

What is the best estimate of the after-tax cost of debt? considering...

Assets
Current assets	$ 38,000,000
Net plant, property, and equipment	101,000,000
Total assets	$139,000,000
Liabilities and Equity
Accounts payable	$ 10,000,000
Accruals	9,000,000
Current liabilities	$ 19,000,000
Long-term debt (40,000 bonds, $1,000 par value)	40,000,000
Total liabilities	$ 59,000,000
Common stock (10,000,000 shares)	30,000,000
Retained earnings	50,000,000
Total shareholders' equity	80,000,000
Total liabilities and shareholders' equity	$139,000,000

The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%.

Answer 1

After tax cost of debt=before tax cost of debt*(1-tax rate)

before tax cost of debt can be found using RATE function in EXCEL

=RATE(nper,pmt,pv,fv,type)

The bond payments are semi-annual

nper=number of periods=2*20=40

pmt=semi-annual coupon payment=(7.25%*1000)/2=36.25

pv=875

fv=1000

=RATE(40,36.25,-875,1000,0)

RATE=4.28%

Semi-annual yield to maturity=4.28%

Annual yield=before tax cost of debt=2*4.28%=8.57%

After tax cost of debt=before tax cost of debt*(1-tax rate)

After tax cost of debt=8.57%*(1-40%)=5.14%