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%**

**FEEL FREE TO ASK DOUBTS**

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