Avicorp has a $13.5 million debt issue outstanding, with a 6.2% coupon rate. The debt has semi-annual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 96% of par value. a. What is Avicorp's pre-tax cost of debt? Note: Compute the effective annual return. b. If Avicorp faces a tax rate, what is its after-tax cost of debt? Note: Assume that the firm will always be able to utilize its full interest tax shield.
Qa:
cost of debt is found by finding the IRR of the cashflows and multiplying it by 2 to get annual cost of debt (since cashflows are semi annual)
It is as shown below;
|
Bond (Annual payment) |
|||||||||||
| Years | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
| Price | 96 | ||||||||||
|
Coupon payment |
3.1 | 3.1 | 3.1 | 3.1 | 3.1 | 3.1 | 3.1 | 3.1 | 3.1 | 3.1 | |
| Par value | 100 | ||||||||||
| Total cashflows | -96 | 3.1 | 3.1 | 3.1 | 3.1 | 3.1 | 3.1 | 3.1 | 3.1 | 3.1 | 103.1 |
| IRR | 3.583% | ||||||||||
| YTM=2*IRR (semi annual bonds) | 7.166% |
cost of debt =7.166%
Qb:
After tax cost of debt= cost of debt*(1-tax rate)
=7.166*(1-tax rate)
note:Since tax rate is not given, assuming a tax rate of 30%.
After tax cost of debt =7.166*(1-.3) =5.16%
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