Question

You are analyzing the cost of debt for a firm. You know that the firm’s 14-year maturity, 8.6 percent coupon bonds are selling at a price of $745.14. The bonds pay interest semiannually. If these bonds are the only debt outstanding for the firm, answer the following questions.What is the after-tax cost of debt for this firm if it has a 30 percent marginal and average tax rate?

Answer 1

8.75%

Step-by-step explanation:

Find the YTM which is the pretax cost of debt.

Using a financial calculator, input the following and adjust the coupon payment, time and interest rate to semi-annual basis.

Maturity of the bond; N= 14*2 = 28

Face value : FV = 1000

Price of the bond ; PV = -745.14

Semiannual Coupon payment; PMT = semiannual coupon rate* Face value

Semiannual Coupon payment; PMT = (8.6%/2)*1000 = 43

then compute the semiannual rate; CPT I/Y = 6.25%

Annual rate; YTM ; pretax cost of debt = 6.25*2 = 12.5%

Next, find aftertax cost of debt;

Aftertax cost of debt = pretax cost of debt (1-tax)

= 0.125 (1 -0.30)

= 0.0875 or 8.75% as a percentage

Therefore; aftertax cost of debt = 8.75%