Question

Calculate the​ after-tax cost of debt for the following bond. The face value of the bond is ​$1,000​, interest is paid​ annually, the coupon rate is 14​% and the bond matures in 7 years. Assume that the corporate tax rate is 38​% and the issue price of the bond was ​$870.

Answer 1

Given about a bond,

Face value = $1000

Coupon rate = 14% paid annually,

Annual coupon payment = 14% of 1000 = $140

Years to maturity = 7

Price of the bond = $870

So, Yield to maturity on the bond can be calculated on financial calculator using following values:

FV = 1000

PMT = 140

N = 7

PV = -870

compute for I/Y, we get I/Y = 17.35

So, Yield to maturity on the bond is 17.35%

For a company, its pretax cost of debt equals its bonds yield to maturity

So, Pretax cost of debt Kd = 17.35%

Tax rate T = 38%

So, After-tax cost of debt = Kd*(1-T) = 17.35*(1-0.38) = 10.76%

the​ after-tax cost of debt is 10.76%