Question

Virginia Beach Bottling has a bond outstanding. The company's coupon rate is 6.5 percent and makes semiannual payments. The bond currently sells for 951 and matures in 23 years. The par value is 1,000 and the company's tax rate is 35 percent. Calculate the aftertax cost of debt for the company?

Answer 1

To calculate the aftertax cost of debt for Virginia Beach Bottling, you need to find the yield to maturity (YTM) of the bond and use it to calculate the before-tax cost of debt. Then, calculate the tax benefit and subtract it from the before-tax cost of debt to find the aftertax cost of debt.

Step-by-step explanation:

The aftertax cost of debt is the effective interest rate paid by a company after accounting for the tax benefits of the interest expense. To calculate the aftertax cost of debt, we need to determine the before-tax cost of debt and then adjust it for the tax benefit.

In this case, the coupon rate is 6.5%, which means the bond pays 6.5% of its par value as interest every year. Since the bond makes semiannual payments, the coupon payment is 6.5% divided by 2, or 3.25%.

The current market price of the bond is $951, which is less than the par value of $1,000. Therefore, the bond is selling at a discount. The discount is the difference between the par value and the market price, which is $1,000 - $951 = $49.

To calculate the before-tax cost of debt, we need to calculate the yield to maturity (YTM) of the bond. The YTM is the rate of return an investor can expect to earn on a bond if it is held until it matures. We can use financial calculators or Excel functions to calculate the YTM.

Once we have the YTM, we can calculate the before-tax cost of debt as the coupon rate plus the capital gain or loss divided by the number of years to maturity. In this case, the number of years to maturity is 23.

1. Calculate the yield to maturity (YTM) of the bond using a financial calculator or Excel.
2. Calculate the before-tax cost of debt as the coupon rate plus the capital gain or loss divided by the number of years to maturity.
3. Calculate the tax benefit as the before-tax cost of debt multiplied by the tax rate.
4. Calculate the aftertax cost of debt as the before-tax cost of debt minus the tax benefit.

In summary, to calculate the aftertax cost of debt for Virginia Beach Bottling, you need to find the yield to maturity (YTM) of the bond and use it to calculate the before-tax cost of debt. Then, calculate the tax benefit and subtract it from the before-tax cost of debt to find the aftertax cost of debt.