Question

Airborne Airlines Inc. has a $1,000 par value bond outstanding with 10 years to maturity. The bond carries an annual interest payment of $90 and is currently selling for $960. Airborne is in a 20 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.

Required:
a. Compute the yield to maturity on the old issue and use this as the yield for the new issue. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
b. Make the appropriate tax adjustment to determine the aftertax cost of debt. (Do not round intermediate calculations.

Answer 1

a. 9.64%

b. 7.71%

Step-by-step explanation:

For this question, we use the RATE formula that is shown in attachment

Given that,

Present value = $960

Future value or Face value = $1,000

PMT = $90

NPER = 10 years

The formula is shown below:

= Rate(NPER;PMT;-PV;FV;type)

The present value come in negative

So, after solving this,

a. The pretax cost of debt is 9.64%

b. And, the after tax cost of debt would be

= Pretax cost of debt × ( 1 - tax rate)

= 9.64% × ( 1 - 0.20)

= 7.71%