Question

Galvatron Metals has a bond outstanding with a coupon rate of 5.7 percent and semiannual payments. The bond currently sells for $943 and matures in 19 years. The par value is $1,000 and the company's tax rate is 39 percent. What is the company's aftertax cost of debt?

2.90%

3.11%

4.01%

3.50%

3.79%

Answer 1

Information provided:

Par value= future value= $1,000

Current price= present value= $943

Time= 19 years*2= 38 semi-annual periods

Coupon rate= 5.7%/2= 2.85%

Coupon payment= 0.0285*1,000= $28.50

Tax rate= 39%

The question is solved by first computing the before tax cost of debt.

Enter the below in a financial calculator to calculate the yield to maturity:

FV= 1,000

PV= -943

N= 38

PMT= 28.50

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

The value obtained is 3.1077.

Therefore, the before tax cost of debt is 3.1077%*2= 6.2154%.

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

                                 = 6.2154%*(1 – 0.39)   

                                 = 3.7914%3.79%

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