Question

Avicorp has a $ 10.7 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 95 % of par value. a. What is​ Avicorp's pre-tax cost of​ debt? Note: Compute the effective annual return. b. If Avicorp faces a 40 % tax​ rate, what is its​ after-tax cost of​ debt? ​Note: Assume that the firm will always be able to utilize its full interest tax shield. a. The cost of debt is nothing​% per year. 

Answer 1

a) Semiannual coupon of the debt = $10.7 million * 5.8%/2 = $310300

Let the six monthly yield to maturity be y, no of coupon payments = 2*5 = 10

Current price of Debt = 95% *$10.7 million = $10165000

So, 10165000 = 310300/y*(1-1/(1+y)^10) + 10700000/(1+y)^10

Using Excel's SOLVER tool to solve for y

y =0.0350124

So, the effective annual YTM (cost of debt) = (1+0.0350124)^2-1 =0.071251 or 7.13%

Pre-tax cost of debt = 7.13%

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

= 7.13%*(1-0.4) = 0.04275 or 4.28%