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Avicorp has a $12
Avicorp has a $12.2 million debt issue? outstanding, with a 5.9% coupon rate. The debt has? semi-annual coupons, the next coupon is due in six? months, and the debt matures in five years. It is currently priced at 95% of par value.
a. What is? Avicorp's pre-tax cost of? debt? Note: Compute the effective annual return.
b. If Avicorp faces a 25% tax? rate, what is its? after-tax cost of? debt?
?Note: Assume that the firm will always be able to utilize its full interest tax shield
Expert Solution
a. Computation of Avicorp's Pre-tax cost of? debt using Rate Function in Excel:
=rate(nper,pmt,-pv,fv)*2
Here,
Rate = Pre-tax cost of? debt = ?
Nper = 5 years * 2 = 10 Periods
PMT = $1,000*5.9%/2 = $29.50
PV = $1,000*95% = $950
FV = $1,000 (Assumed)
Substituting the values in formula:
=rate(10,29.50,-950,1000)*2
Rate or Pre-tax Cost of Debt = 7.11%
Computation of Effective Annual Rate (EAR):
Effective Annual Rate (EAR) = (1+i/n)^n - 1
= (1+7.11%/2)^2 - 1
= 1.0723 - 1
Effective Annual Rate (EAR) = 0.0723 or 7.23%
b. Computation of After-tax Cost of Debt:
After-tax Cost of Debt = Effective Annual Rate (EAR) * (1-Tax Rate)
= 7.23%*(1-25%)
After-tax Cost of Debt = 5.42%
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