Question

**The XGENZ Corporation issued a 30-year, 7 percent semiannual bond 3 years ago. The bond currently sells for 93 percent of its face value. The company’s tax rate is 35 percent.****What is the pretax cost of debt?****What is the aftertax cost of debt?****Which is more relevant, the pretax or the aftertax cost of debt? Why?**

**Suppose the book value of the debt issue is $85 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 12 years left to maturity; the book value of this issue is $35 million, and the bonds sell for 59 percent of par.****What is the company’s total book value of debt?****The total market value?****What is your best estimate of the aftertax cost of debt now?**

Answer #1

Par Value =1000

Semi annual coupon =7%*1000/2 =35

Price =93%*1000 =930

YTM using financial calculator

N=54;PMT=35;PV=-930;FV=1000;CPT =3.8074%

Cost of Debt or YTM =2*3.8074% =7.6148% or **7.61%**

b. After tax cost of debt =7.6148%*(1-35%) =**4.95%**

c. After tax cost of debt is more relevant as interest payments are
tax deductible. Hence provides benefit of interest tax
shield.

d. i. Total book value of Debt =85+35 =**120**

ii. Total Market Value of debt =93%*Book Value of Bond+59%*Book
Value of zero coupon bond

=93%*85+59%*35 =**99.7**

iii. Before tax cost of debt of zero coupon bond =(100/59)^(1/12)-1
=4.495%

After tax cost of Debt =(Weight of Bond*Cost of debt+Weight of zero
coupon bond*Cost of debt )*(1-tax rate)

=(93%*85/99.7*7.6148%+59%*35/99.7*4.495%)*(1-35%) =4.53%

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