Question

Carraway Seed Company is issuing a ​$1,000 par value bond that pays 9 percent annual interest and matures in 9 years. Investors are willing to pay ​$955 for the bond. Flotation costs will be 9 percent of market value. The company is in a 38 percent tax bracket. What will be the​ firm's after-tax cost of debt on the​ bond?

Answer 1

Answer:

Par value = $1,000

Annual Interest = 1000 * 9% = $90

Time to maturity = 9 years

Price = $955

Flotation costs= 9% of market value

Amount realized = Price - Flotation costs = 955 * (1 - 9%) = $869.05

To get cost of debt we will use RATE function of excel:

= RATE (nper, pmt, pv, fv, type)

= RATE (9, 90, 869.05, 1000, 0)

=11.4021%

Before tax cost of debt on the bond = 11.4021%

Firm's after-tax cost of debt on the​ bond = Before tax cost of debt * (1 - Tax rate) = 11.4021% * (1 - 38%) = 7.07%

Firm's after-tax cost of debt on the​ bond =7.07%