Question

1. 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
   		5.36 percent
   		5.45 percent
   		6.11 percent
   		8.74 percent

Answer 1

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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