Question

uppose a company will issue new 25-year debt with a par value of $1,000 and a coupon rate of 9%, paid annually. The issue price will be $1,000. The tax rate is 35%. If the flotation cost is 2% of the issue proceeds, then what is the after-tax cost of debt? Disregard the tax shield from the amortization of flotation costs. Round your answer to two decimal places.
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What if the flotation costs were 11% of the bond issue? Round your answer to two decimal places.

Answer 1

Floatation cost = 1000*2% = 20
Annual amortization of Floatation cost = 20/25 = 0.80
Annual Interest paid = 1000*9% = 90
After tax interest = 90 (1-0.35) = 58.50
Annual after tax cost = 58.50+0.80 = 59.30
After tax cost of debt = 59.30 / 1000*100 = 5.93%
Floatation cost = 1000*11% = 110
Annual amortization of Floatation cost = 110/25 = 4.40
Annual Interest paid = 1000*9% = 90
After tax interest = 90 (1-0.35) = 58.50
Annual after tax cost = 58.50+4.40 = 62.90
After tax cost of debt = 62.90 / 1000*100 = 6.29%