The Corner Bakery has a bond issue outstanding that matures in 7 years. The bonds pay interest semi-annually. Currently, the bond prices are quoted at $1014 per $1000 face value and carry a 9 percent coupon. What is the firm's aftertax cost of debt if the tax rate is 30 percent?
4.88 percent |
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5.36 percent |
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5.45 percent |
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6.11 percent |
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8.74 percent |
Price of a bond = Present value of all semi-annual coupons and face value discounted at the semi-annual cost of debt.
Face value = 1000
Price = 1014
Semi - annual coupons = 0.09*1000/2 = 45
Number of payments = 7*2 = 14
1014 = 45/(1+ semi-annual cost of debt)^1 + 45/(1+ semi-annual cost of debt)^2 + 45/(1+ semi-annual cost of debt)^3 + 45/(1+ semi-annual cost of debt)^4 + ................ 45/(1+ semi-annual cost of debt)^14 + 1000/(1+ semi-annual cost of debt)^14
We will use the heat and trial method to get that value for which the above equation satisfies.
Semi -annual cost of debt = 4.36
Annual cost of debt = 8.72
After-tax cost of debt = 8.72 *(1-0.3) = 6.11% Answer
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