Question

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.

Answer #1

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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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 40% tax rate, what is its
after-tax cost of debt? Note: Assume that the firm
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