Question

Micro Spinoffs Inc. issued 20-year debt a year ago at par value with a coupon rate of 4%, paid annually. Today, the debt is selling at $1,070. If the firm’s tax bracket is 21%, what is its percentage cost of debt? Assume a face value of $1,000. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

Face Value = $1,000
Current Price = $1,070

Annual Coupon Rate = 4.00%
Annual Coupon = 4.00% * $1,000
Annual Coupon = $40

Time to Maturity = 19 years

Let Annual YTM be i%

$1,070 = $40 * PVIFA(i%, 19) + $1,000 * PVIF(i%, 19)

Using financial calculator:
N = 19
PV = -1070
PMT = 40
FV = 1000

I = 3.49%

Annual YTM = 3.49%

Before-tax Cost of Debt = Annual YTM
Before-tax Cost of Debt = 3.49%

After-tax Cost of Debt = Before-tax Cost of Debt * (1 - Tax Rate)
After-tax Cost of Debt = 3.49% * (1 - 0.21)
After-tax Cost of Debt = 2.76%