Question

A bond has a $15million face value and a coupon rate of 9 percent. It has...

A bond has a $15million face value and a coupon rate of 9 percent. It has floatation costs of 5 percent of the face value. The bond matures in 10 years. The firm’s average tax rate is 30 percent and its marginal tax rate is 21 percent. Compute the after-tax cost of debt.

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Answer #1

Answer:

Face Value = $15,000,000
Current Price = $15,000,000 * (1 – 0.05)
Current Price = $14,250,000

Annual Coupon Rate = 9%
Annual Coupon = 9% * $15,000,000 = $1,350,000

Time to Maturity = 10 years

Let Annual YTM be i%

$14,250,000 = $1,350,000 * PVIFA(i%, 10) + $15,000,000 * PVIF(i%, 10)

Using financial calculator:
N = 10
PV = -14,250,000
PMT = 1,350,000
FV = 15,000,000

I = 9.81%

Annual YTM = 9.81%

Before-tax Cost of Debt = 9.81%
After-tax Cost of Debt = 9.81% * (1 - 0.21)
After-tax Cost of Debt = 7.75%

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