Question

Avicorp has a $10.4 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 93% of par value. If Avicorp faces a 25% tax rate, what is its after-tax cost of debt? Express your answer as a percentage with two decimals.

Answer 1

Cost of Debt = [Coupon + Pro-rated Discount]/[(Purchase Price + Redemption Price)/2]

Where,

Coupon = Par Value*Coupon Rate = 1000*5.8%/2 = 29

Pro Rated Discount = [(Redemption Price-Purchase Price)/Period to Maturity] = [(1000-930)/(5*2)] = 7

Redemption Price(assuming at par) = 1000

Therefore, Kd = [29+7]/[(930+1000)/2] = 36/965 = 0.037306 = 3.7306%

Above Kd is Half Yearly. Therefore, Annual Kd = Half Yearly*2 = 3.7306%*2 = 7.4612%

Pre-Tax Cost of Debt = 7.4612%

After Tax Cost of Debt = Pre Tax Cost of Debt*(1-Tax Rate) = 7.4612(1-0.25) = 5.5959 = 5.6%(approximately)