Question

g to issue a $1,000 par value, 20-year noncallable bond with a 7.00% annual coupon, paid semiannually. The stock is selling for $1000. The company's marginal tax rate is 40.00%, but the new Congress is considering a change in the corporate tax rate to 45.00%. By how much would the component cost of debt used to calculate the WACC change if the new tax rate was adopted?

Answer 1

The debt cost component would change by 0.35%

Step-by-step explanation:

The after tax cost of debt before the new tax rate is implemented is computed thus:

In calculating the after tax cost of debt, the rate formula in excel needs to be used first of all to compute pre-tax cost of debt

=rate(nper,pmt,-pv,fv)

nper is the number of times the bond is expected to pay coupon interest,that is 20*2=40

pmt is the semi-annual coupon payment payable by the bond i.e$1000*7%/2=$35

The pv is the price of the bond at $1000

The fv is the face of the bond at $1000 as well

=rate(40,35,-1000,1000)

rate=3.5%

The 3.5 % is a semi-annual rate ,annual rate is 7%(3.5%*2)

After tax cost of debt at 40% tax rate =7%*(1-0.4)

=4.2%

After tax cost of debt at 45% tax rate =7%*(1-0.45)

=3.85%

The difference is 4.2%-3.85%=0.35%