Question

Avicorp has a $ 13.6 million debt issue​ outstanding, with a 5.8 % coupon rate. The debt has​ semi-annual coupons, the next coupon is due in six​ months, and the debt matures in five years. It is currently priced at 94 % of par value. a. What is​ Avicorp's pre-tax cost of​ debt? Note: Compute the effective annual return. b. If Avicorp faces a 40 % tax​ rate, what is its​ after-tax cost of​ debt? ​Note: Assume that the firm will always be able to utilize its full interest tax shield.

Answer 1

a)
FV = 1000
PMT = 1000 * 5.8% / 2 = 29
Nper = 5 * 2 = 10
PV = 1000 * 94% = 940

Pre-tax cost of debt can be calculated by using the following excel formula:
=RATE(nper,pmt,pv,fv)*2
=RATE(10,29,-940,1000)*2
= 7.25%

Effective annual return = (1+r / n)^n - 1
= (1 + 0.0725 / 2)^2 - 1
= 1.03625^2 - 1
= 7.3836% or 7.38%

Effective annual return = 7.3836% or 7.38%

b)
After tax cost of debt = Pre-tax cost of debt * (1 - tax rate)
= 7.3836% * (1 - 0.40)
= 4.43%

After tax cost of debt = 4.43%

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