Question

Carraway Seed Company is issuing a $1,000 par value bond that pays 8 percent annual interest and matures in 9 years. Investors are willing to pay $950 for the bond. Flotation costs will be 14 percent of market value. The company is in a 38 percent tax bracket. What will be the​ firm's after-tax cost of debt on the​ bond?

Answer 1

Cost of debt before tax =[ i + ( D - NP) / n ] / ( D + NP)/2

Here I = annual interest payment = 1000 * 8% = $ 80

D = Face value = $ 1,000

NP = Net proceeds means proceeds net of flotation cost = $ 950 - $ 950 * 14% = $ 817

n = numbers of years to maturity = 9 years

= 80 + ( 1000 - 817) / 9 ] / ( 1000 + 817) /2

Cost of debt before tax = 11.0438452%

Cost of debt after tax = Cost of debt before tax * ( 1 - tax rate)

= 11.0438452% * ( 1 - 0.38)

Cost of debt after tax = 6.847184%