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Tiny Tots has debt​ outstanding, currently selling for ​$800 per bond. It matures in 6​ years,...

Tiny Tots has debt​ outstanding, currently selling for ​$800 per bond. It matures in 6​ years, pays interest​ annually, and has a 11​% coupon rate. Par is ​$1000​,and the​ firm's tax rate is 25​%.What is the​ after-tax cost of​ debt?

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Answer #1

Calculating pre-tax cost of debt:

Price of bond (PV) = (-$800)

Future value of bond (FV) = Par value = $1000

Semi-annual coupon payment (PMT) = 1000 x 11% x 1/2 = $55

No of pending semi-annual coupon payments (N) = 12

Yield to maturity (YTM) = ?

Using financial calculator or Rate function in excel,

Yield to maturity (YTM) = 8.178% per semi-annum = 16.357% p.a.

Pre-tax cost of debt = 16.357% p.a.

Therefore, post-tax cost of debt = 16.357 x (1-tax) = 16.357 x (1-25%) = 12.268% p.a.

Thumbs up please if satisfied. Thanks :)

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