Question

A company's 6% coupon rate, semiannual payment, $1,000 par value bond that matures in 30 years sells at a price of $643.47. The company's federal-plus-state tax rate is 40%. What is the firm's after-tax component cost of debt for purposes of calculating the WACC? (Hint: Base your answer on the nominal rate.) Round your answer to two decimal places.

Answer 1

The before tax cost of debt is calculated by computing the yield to maturity.

Information provided:

Par value= future value= $1,000

Market price= present value= $643.47

Time= 30 years*2= 60 semi-annual periods

Coupon rate= 6%/2= 3%

Coupon payment= 0.03*1,000= $30

The yield to maturity is calculated by entering the below in a financial calculator:

FV= 1,000

PV= -643.47

N= 60

PMT= 30

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

The value obtained is 4.83

Therefore, the yield to maturity is 4.83%*2= 9.66%   

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

= 9.66%*(1 - 0.40)

= 5.7960% 5.80%.