Question

Revive Co. has outstanding 20-year noncallable bonds with a face value of $1000. These bonds have a current market price of $1382.73 and an annual coupon rate of 13%. The comp;any faces a tax rate of 35%.

If the company wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt?A. 6.9%B 5.75%C 5.18%D 6.61%

Answer 1

5.75%

Step-by-step explanation:

Firstly, we need to find the yield-to-maturity (YTM) of current outstanding bond as below:

Bond market price = Coupon/(1 + YTM) + Coupon/(1 + YTM)^2 + Coupon/(1 + YTM)^3 +...+ Coupon/(1 + YTM)^20 + Face value/(1 + YTM)^20, or:

1,382.73 = 130/(1 + YTM) + 130/(1 + YTM)^2 + 130/(1 + YTM)^3 +...+ 130/(1 + YTM)^20 + 1,000/(1 + YTM)^20

Solve the equation, we get YTM = 8.85%.

So, if he company wants to issue new debt, its after-tax cost of debt is 8.85% x (1 - 35%) = 5.75%