Question

​Rover's Dog Care has outstanding debt currently selling for ​$800 per bond. It matures in 8 ​years, pays interest​ semiannually, and has a coupon rate of 11​%.If par is ​$1000and the tax rate is 45​%,what is the​ after-tax cost of​ debt?

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) = 16

Yield to maturity (YTM) = ?

Using financial calculator or Rate function in excel,

Yield to maturity (YTM) = 7.72% per semi-annum = 15.44% p.a.

Pre-tax cost of debt = 15.44% p.a.

Therefore, post-tax cost of debt = 15.44 x (1-tax) = 15.44 x (1-45%) = 8.49% p.a.

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