Final answer:
The firm's after-tax cost of debt on the bond is 7.06%.
Step-by-step explanation:
The after-tax cost of debt on the bond can be calculated by first finding the net price of the bond, which is the market value minus the flotation costs. In this case, the net price is $980 - (0.13 * $980) = $850. Next, we need to calculate the after-tax interest expense, which is the annual interest payment minus the tax savings. The annual interest payment is $1000 * 0.08 = $80. The tax savings is $80 * 0.25 = $20. So the after-tax interest expense is $80 - $20 = $60. Finally, we can calculate the after-tax cost of debt by dividing the after-tax interest expense by the net price of the bond and multiplying by 100. The after-tax cost of debt is ($60 / $850) * 100 = 7.06%.
The student is asking about the after-tax cost of debt for a bond being issued by the Carraway Seed Company. To calculate this, we first need to find the cost of debt before taxes, which is the annual interest payment divided by the net proceeds from issuing the bond. The annual interest is $80 (8% of $1000), and the net proceeds are the price investors pay ($980) minus the flotation cost (13% of $980). Then, we calculate the after-tax cost of debt by multiplying the pre-tax cost of debt by (1 minus the tax rate), which in this case is (1 - 0.25).