Question

Russell Container Corporation has a $1,000 par value bond outstanding with 25 years to maturity. The bond carries an annual interest payment of $97 and is currently selling for $950 per bond. Russell Corp. is in a 20 percent tax bracket. The firm wishes to know what the after tax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.

a. Compute the yield to maturity on the old issue and use this as the yield for the new issue. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

b. Make the appropriate tax adjustment to determine the after tax cost of debt. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Answer 1

a.Information provided:

Par value= future value= $1,000

Current price= present value= $950

Time= 25 years

Coupon payment= $97

The yield to maturity is computed by entering the below in a financial calculator:

FV= 1,000

PV= -950

N= 25

PMT= 97

Press the CPT key and I/Y to compute the yield to maturity.

The answer obtained is 10.2620 10.26%.

b.After tax cost of debt = Before tax cost of debt*(1 - tax rate)

= 10.2620%*( 1 - 0.20)

= 8.2096% 8.21%.

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