Question

Suppose a company currently has some bonds outstanding in the market. The bonds have 10 years until maturity, they pay a coupon rate of 6% on a semiannual basis. If the company’s bonds are selling for $965 now, and the company’s tax rate is 40%, what is its after-tax cost of debt? What is Pretax cost of debt? State Appropriate Mathematical formula to be used and detailed steps in the solution calculations.

Answer 1

Par Value of Bond = $1,000

Coupon rate = 6%

Semiannual Coupon Payment = $1,000 × 6% / 2

= $30

Semiannual Coupon payment is $30.

Prestax cost of debt = 6.47%

tax rate = 40%

after tax cost of debt = 6.47% × (1 - 40%)

= 3.88%

After tax cost of debt is 3.88%.