Question

Costly Corporation plans a new issue of bonds with a par value of $1000, a maturity of 36 years, and an annual coupon rate of 11.0%. Flotation costs associated with a new debt issue would equal 8.0% of the market value of the bonds. Currently, the appropriate discount rate for bonds of firms similar to Costly is 9.0%. The firm's marginal tax rate is 30%. What will the firm's true cost of debt be for this new bond issue? options: 8.37% 9.83% 11.96% 6.88% 13.43%

Answer 1

Proceeds = issue price*(1-flotation cost) = 1000*(1-0.08)=920

K = N

Proceeds =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =36

920 =∑ [(11*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^36

k=1

YTM = 11.974%

After tax rate = YTM * (1-Tax rate)

After tax rate = 11.974 * (1-0.3)

After tax rate = 8.37%