Question

Avicorp has a $ 14.2 million debt issue? outstanding, with a 5.8% 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 40 % tax? rate, what is its? after-tax cost of? debt?

Answer #1

r = | 5.8/2 = | 2.90% | ||||

n = | 5 x 2 = | 10 | ||||

Face value = | 1000 | |||||

Price = | 1000 x 96% = | 960 | ||||

Coupon = | 1000 x r = | 29 | ||||

YTM is the rate at which PV of cash flows = | Price | |||||

960 | = | 29 x PVAF(YTM,n) + 1000 x PVIF(YTM,n) | ||||

YTM | Price | |||||

3.00% | 991.47 | |||||

YTM | 960 | |||||

4.00% | 910.78 | |||||

Using linear Intrpolation - | ||||||

YTM - 3/4-3 = | 960-991.47/(910.78-991.47) | |||||

YTM - 3/4-3 = | -31.47/-80.69 | |||||

YTM - 3 = | 0.3900 | |||||

YTM = | 3.3900 | Semi annual | ||||

Approx | ||||||

Or | 3.39 x 2 | |||||

6.780021 | ||||||

Pre tax cost of debt = | 6.7800 | |||||

Post tax cost of debt = | 6.78 x (1-40%) = | 4.0680 | ||||

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