Question

At the present time, Perpetualcold Refrigeration Company (PRC) has 10-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,278.41 per bond, carry a coupon rate of 11%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 25%. If PRC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)

Answer 1

after-tax cost of debt 5.2725%

Step-by-step explanation:

We will solve for the market rate of the bonds which is the one that makes the maturity and coupon payment equal to its current market price:

We sovle it using a financial calcualtor or excel goal seek tool

`C * (1-(1+r)^(-time) )/(rate) = PV\\`

C 110.000 (1,000 x 11%)

time 10 years

rate 0.070304812

`110 * (1-(1+0.0703048118151927)^(-10) )/(0.0703048118151927) = PV\\`

PV $771.5066

`(Maturity)/((1 + rate)^(time) ) = PV`

Maturity 1,000

time 10 years

rate 0.070304812

`(1000)/((1 + 0.0703048118151927)^(10) ) = PV`

PV 506.90

PV c $771.5066

PV m $506.9034

Total $1,278.4100

Now that we find that market rate is 7.03%

we calcautle the after tax cost of debt:

7.03 x (1 - 25%) = 5.2725%