Question

Airborne Airlines Inc. has a $1,000 par value bond outstanding with 20 years to maturity. The bond carries an annual interest payment of $102 and is currently selling for $880. Airborne is in a 30 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.

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. Input your answer as a percent rounded to 2 decimal places.)

Answer 1

(a) 11.64%

(b) 8.15%

Explanation:

Airborne airlines has an annual interest of payment= $102

Principal payment= $1,000

Time to maturity= 20 years

Current price of the bond= $880

The formular for calculating the yield on maturity is

[ Annual interest payment+Principal payment-(price of the bond/number of years to maturity)] / 0.6(price of the bond) + 0.4(principal payment)

(a) [102+(1000-880)/20)]/ [0.6(880) + 0.4(1000)]

= [102+ (120/20)]/ [528+400]

= [102+6]/ 928

= 108/928

= 11.637%

= 11.64% ( to 2 decimal places)

(b) Kd= Yield(1-T)

Kd= 11.64(1-0.30)

Kd= 11.64×0.7

Kd= 8.145%

Kd= 8.15%( to 2 decimal places)

Hence the yield to maturity on the new issue is 11.64% and the aftertax cost of debt is 8.15%