Question

Gillian Stationery Corporation needs to raise ​$563,000 to improve its manufacturing plant. It has decided to issue a ​$1,000 par value bond with an annual coupon rate of 8.1 percent with interest paid semiannually and a 15​-year maturity. Investors require a rate of return of 11.4 percent.

a. Compute the market value of the bonds.

b.  How many bonds will the firm have to issue to receive the needed​ funds?

c.  What is the​ firm's after-tax cost of debt if the​ firm's tax rate is 34 percent?

Answer 1

a.Information provided:

Par value= future value= $1,000

Time= 15 years*2= 30 semi-annual periods

Coupon rate= 8.1%/2= 4.05%

Coupon payment= 0.0405*1,000= $40.50 per semi-annual period

Yield to maturity= 11.4%/2= 5.7% per semi-annual period

The market value of the bond is calculated by computing the present value.

Enter the below in a financial calculator to compute the present value:

FV= 1,000

PMT= 40.50

I/Y= 5.7

N= 30

Press the CPT key and PV to compute the present value.

The value obtained is 765.40.

Therefore, the market value of the bonds is $765.40.

b.Number of bonds to issue to receive the needed funds:

= $563,000 / $765.40

= 735.56 736 bonds.

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

  = 11.4%(1 - 0.34)

= 7.5240% 7.52%.