Question

x

Cost of debt using the approximation formula   For the following

​$1,000​-par-value

​bond, assuming annual interest payment and a

24​%

tax​ rate, calculate the ​after-tax cost to maturity using the approximation

formula.

Life	Underwriting fee	Discount ​(−​) orpremium ​(+​)	Coupon interest rate
20 years	​$40	−$30	8​%

The​ after-tax cost of financing using the approximation formula is

nothing​%.

​(Round to two decimal​ places.)

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TABLE:

Answer 1

after-tax cost of financing = yield * (1 - tax rate)

Yield = (C + (F - P) / n) / (F + P) / 2)

where C = annual coupon payment = face value * coupon rate = $1,000 * 8% = $80

F = face value

P = net proceeds = face value - underwriting fee - discount = $1,000 - $40 - $30 = $930

n = years to maturity

Yield = ($80 + ($1,000 - $930) / 20) / ($1,000 + $930) / 2)

Yield = 8.65%

after-tax cost of financing = yield * (1 - tax rate)

after-tax cost of financing = 8.65% * (1 - 24%)

after-tax cost of financing = 6.58%