Question

Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of 3.60 percent, a par value of $2,000 per bond, matures in 7 years, has a total face value of $4.1 million, and is quoted at 104 percent of face value. The second issue has a coupon rate of 6.34 percent, a par value of $1,000 per bond, matures in 26 years, has a total face value of $8.4 million, and is quoted at 92 percent of face value. Both bonds pay interest semiannually. The company's tax rate is 39 percent. What is the firm's weighted average aftertax cost of debt?

Answer 1

3.38%

Step-by-step explanation:

For computing the firm's weighted average after tax cost of debt first we have to find out the rate i.e to be shown in the attachment

For the first issue

Given that,

Present value = $1,000 × 104% = $1,040

Future value or Face value = $1,000

PMT = 1,000 × 3.6% ÷ 2 = $18

NPER = 7 years × 2 = 14 years

The formula is shown below:

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

The present value come in negative

So, after applying the above formula

1. The pretax cost of debt is 1.48% × 2 = 2.96%

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

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

= 2.96% × ( 1 - 0.39)

= 1.81%

For the second issue

Given that,

Present value = $1,000 × 92% = $920

Future value or Face value = $1,000

PMT = 1,000 × 6.34% ÷ 2 = $31.7

NPER = 26 years × 2 = 52 years

The formula is shown below:

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

The present value come in negative

So, after applying the above formula

1. The pretax cost of debt is 3.51% × 2 = 7.02%

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

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

= 7.02% × ( 1 - 0.39)

= 4.28%

Now the weighted average cost of capital after tax cost of debt is

Particulars Market value Weight After tax cost of debt WACC

(In millions) (a ÷ c or a ÷ b)

a First issue $4.26 0.3556 1.81% 0.006426

($4.1 ×104%)

b. Second issue $7.73 0.6444 4.28% 0.027569

($8.4 × 92%)

c. Total $11.99 3.38%