Question

Galvatron Metals has a bond outstanding with a coupon rate of 6.9 percent and semiannual payments. The bond currently selle for $1,877 and matures in 19 years. The par value is $2,000 and the company's tax rate is 21 percent. What is the company's aftertax cost of debt?

Answer 1

To calculate the after-tax cost of debt for Galvatron Metals' bond, one must first find the yield to maturity (YTM) and then adjust it for taxes. The formula is Aftertax Cost of Debt = YTM × (1 - Tax Rate), with a tax rate of 21 percent.

Step-by-step explanation:

The student has asked about calculating the after-tax cost of debt for a bond with semiannual payments. To find this, we need to determine the yield to maturity (YTM) on the bond first and then adjust it for taxes, as the after-tax cost of debt is the YTM multiplied by (1 - tax rate).

Although the question does not provide all the required details to calculate the YTM accurately, in a real scenario, we would use the current bond price ($1,877), the annual coupon rate (6.9% of $2,000, which is $138, but paid semiannually so $69 per payment), the face value ($2,000), and the maturity period (19 years or 38 semiannual periods) in a financial calculator or a present value of annuity formula to find the YTM.

Once the YTM is determined, we would calculate the after-tax cost of debt by applying the tax rate: Aftertax Cost of Debt = YTM × (1 - Tax Rate). The tax rate given is 21 percent, so the formula would include this tax rate for the adjustment.