Question

Currently, Warren Industries can sell 20 dash year​, ​$1 comma 000​-par-value bonds paying annual interest at a 9​% coupon rate. Because current market rates for similar bonds are just under 9​%, Warren can sell its bonds for ​$980 ​each; Warren will incur flotation costs of ​$20 per bond. The firm is in the 28​% tax bracket. a. Find the net proceeds from the sale of the​ bond, Upper N Subscript d. b. Calculate the​ bond's yield to maturity​ (YTM​) to estimate the​ before-tax and​ after-tax costs of debt. c. Use the approximation formula to estimate the​ before-tax and​ after-tax costs of debt.

Answer 1

a. Cash proceeds $960

b. Cost of Debt Before tax 9.4% and after tax 6.8%

c. Cost of Debt Before tax 9.39% and after tax 6.76%

Step-by-step explanation:

a.

Cash proceed from the sale of bond is the net selling price and the floating cost of the bonds.

Cash proceed = Selling price - Floating cost = $980 - $20 = $960

b.

Yield to maturity is the annual rate of return that an investor receives if a bond bond is held until the maturity.

Yield to maturity = [ C + ( F - P ) / n ] / [ (F + P ) / 2 ]

Yield to maturity = [ $90 + ( $1,000 - $960 ) / 20 ] / [ ( $1,000 + $960 ) / 2 ]

Yield to maturity = 9.4%

Cost of debt before tax = 9.4%

Cost of debt after tax = 9.4% ( 1 - 0.28 ) = 6.8%

c.

Yield to maturity = [ C + ( F - P ) / n ] / [ (F + P ) / 2 ]

Yield to maturity = [ $90 + ( $1,000 - $960 ) / 20 ] / [ ( $1,000 + $960 ) / 2 ]

Yield to maturity = 9.39%

Cost of debt before tax = 9.39%

Cost of debt after tax = 9.19% ( 1 - 0.28 ) = 6.76%