Question

Great Seneca Inc. sells $100 million worth of 25-year to maturity 13.76% annual coupon bonds. The net proceeds (proceeds after flotation costs) are $992 for each $1,000 bond. The firm's marginal tax rate is 30%. What is the after-tax cost of capital for this debt financing?

The Black Bird Company plans an expansion. The expansion is to be financed by selling $53 million in new debt and $148 million in new common stock. The before-tax required rate of return on debt is 5.16% percent and the required rate of return on equity is 18.52% percent. If the company is in the 34 percent tax bracket, what is the weighted average cost of capital?

Answer 1

Q1) Using financial calculator to calculate the ytm of bond

Inputs: N= 25

Pv= -992

Pmt= 13.76% × 1,000 = 137.6

Fv= 1,000

I/y= compute

We get, ytm of the bond as 13.876%

After tax cost of debt = ytm (1-tax rate)

= 13.876% (1-0.30)

= 13.876% (0.70)

= 9.71%

Q2) Total investment = debt + equity

= 53 + 148

= 201

Weight of debt= 53/ 201 = 0.2637

Weight of equity = 148/ 201 = 0.7363

After tax cost of debt = ytm (1-tax rate)

= 5.16% (1-0.34)

= 5.16% (0.66)

= 3.4056%

WACC= weight of debt × after tax cost of debt + Weight of equity × cost of equity

= 0.2637× 3.4056% + 0.7363 × 18.52%

= 0.898% + 13.64%

= 14.54%

Note:- answer might differ a bit due to rounding off.