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Homework answers / question archive / Avicorp has a $12

Avicorp has a $12

Finance

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

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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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