Question

XYZ Company is undergoing a major expansion. The expansion will be financed by issuing new 16-year, $1,000 par, 8% annual coupon bonds. The market price of the bonds is $1,020 each. Flotation expense on the new bonds will be $60 per bond. The marginal tax rate is 35%. What is the post-tax cost of debt for the newly-issued bonds?

Answer 1

Where P = Current Market Price = $1,020

C = Coupon payments = $80

F = floatation costs = $60

r_d = cost of funds = ?

t = time

n = number of years = 16

We can find r_d with the help of financial calculator

PMT = 80

FV = 1000

PV = 1020 - 60 = 960

N = 16

CPT => I/Y = 8.465%

After tax cost of debt = 8.465 * (1-tax) = 5.50%