Question

William metals has a bond outstanding with a coupon rate of 6.6 percent and semiannual payments. The bond currently sells for 98.75% of the par and matures in 15 years. The par value is $2,000 and the companys tax rate is 21 percent. What is the companys after-tax cost of debt?

Answer 1

Given about William metals' bond,

Face value of bond = $2000

coupon rate = 6.6% paid semiannually,

So, semiannual coupon = (6.6%/2) of 2000 = $66

bond sells at 98.75% of par value.

So bond price = 98.75% of 2000 = $1975

years to maturity = 15 years

Bond's YTM can be calculated using Financial calculator with following values:

FV = 2000

PV = -1975

N = 2*15 = 30

PMT = 66

Solve for I/Y, we get I/Y = 3.367

So, YTM of the bond = 2*3.367 = 6.73%

For a company, its pretax cost of debt equals its bond's YTM

So, Pretax cost of debt Kd = 6.73%

tax rate = 21%

So, after-tax cost of debt = Kd*(1-Tax rate) = 6.73*(1-0.21) = 5.32%