Question

Galvatron metals has a bond outstanding with a coupon rate of 5.8 percent and semiannual payments. the bond currently sells for $1,954 and matures in 22 years. the par value is $2,000 and the company's tax rate is 25 percent. what is the company's aftertax cost of debt?

O 2.94%
O 3.49%
O 4.00%
O 3.15%
O 4.97%

Answer 1

The after-tax cost of debt for Galvatron Metals is calculated using the coupon payment, the current bond price, and the company's tax rate. By inputting these values into the after-tax cost of debt formula, the result is 4.97%.

Step-by-step explanation:

To calculate the after-tax cost of debt for Galvatron Metals, we utilize the current market price of the bond, the coupon rate, and the company's tax rate. The company has a bond with a 5.8 percent coupon rate, which means the annual coupon payment is 5.8 percent of the par value of $2,000, resulting in an annual payment of $116, paid semiannually as $58 every six months. Since the bond is selling for $1,954 and the tax shield provided by the interest expense must be considered, we use the following formula for the after-tax cost of debt:

After-tax cost of debt = (Annual interest payment / Current bond price) * (1 - Tax rate)

Therefore, the after-tax cost of debt is ($116 / $1,954) * (1 - 0.25) = 0.0497 or 4.97 percent. The appropriate selection from the given options is 4.97%.