Question

  ​Currently, Warren Industries can sell 10- year​,​ $1,000 bonds paying annual interest at a 9 ​% coupon rate. As a result of current interest​ rates, the bonds can be sold for $1,060 each before incurring flotation costs of $30per bond. The firm is in the 35% tax bracket.

a. Find the net proceeds from the sale of the​ bond, Nd.

b.  Calculate the​ bond's yield to maturity​ (YTM​) to estimate the​ before-tax and​ after-tax costs of debt

.c.  Use the approximation formula to estimate the​ before-tax and​ after-tax costs of debt. a.The net proceeds from the sale of the​ bond,Nd.

Answer 1

a. The net proceeds of this bond is = $1060 - $30 = $1030

b. The YTM of this bond is :

The YTM can be calculated as :

$1030 = 120/(1+YTM)^1 + 120/(1+YTM)^2 +...... 1120/(1+YTM)^15

So, solving for the YTM we get,

YTM = 11.48%

The before tax cost of debt is 11.48%

The after tax cost of debt = 11.48% *0.65

=7.46%

c. Using the approximate formula we can calculate the YTM as,

YTM = Coupon + (price - face value ) /years to maturity /(price + face value)/2

=120 + (1030 - 1000)/10/(1030 + 1000)/2

=123/1015

= 12.118 %

After tax cost of debt = 12.118% *0.65

=7.88% (rounded off to two decimal places)