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9. Company BW has issued 8,000 corporate bonds with a maturity value of $1,000 and a...

9. Company BW has issued 8,000 corporate bonds with a maturity value of $1,000 and a coupon rate of 7%. Coupon payments are made every 6 months and those bonds will mature in a year from today. Current market price of those bonds is $976.86. Marginal corporate income tax rate is 34%, find the annual after-tax cost of debt.

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Answer #1

We know that,

Price of a bond = Present value of all semi-annual coupon and face value discounted at semi-annual ytm.

Number of payments = 2

Face value = 1000

Semi-annual Coupon = 0.07*1000/2 = 35

Price = 976.86

Tax = 34

976.86 = 35/(1+semi-annual ytm)^1 + 35/(1+semi-annual ytm)^2 + 1000/(1+ semi-annual ytm)^2

We will use the heat and trial method to get that value for which the above equation satisfies.

Semi-annual YTM = 4.74

Before-tax cost of debt = 9.48%

After-tax cost of debt = 9.48 * (1-0.34) = 6.26% Answer

Please let me know in case you have any queries and I will be happy to assist you.

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