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Using the cost of debt approximation formula, determine the pre-tax cost for a bond that sells at $ 925 par value and pays a coupon of $ 85 for 20 years
Using the cost of debt approximation formula, determine the pre-tax cost for a bond that sells at $ 925 par value and pays a coupon of $ 85 for 20 years. The flotation costs are $ 5 per bond. You must show the calculations to receive a score for your answer. Problem 2: For the case in problem 3, calculate the cost of debt after taxes if the company's tax liability is 40%. You must show the calculations to receive a score for your answer.
Expert Solution
1) YTM = Interest +(Face value -current market price less floatation cost/n) / (Face value + current market price less floatation cost/2)
Here interest = 85 $
Face value = $ 1000
Current market price less floatation cost = 925 - 5 = 920 $
n = no of coupon payment = 20
Thus YTM = 85 + (1000 - 920)/20 / ( (1000+920 )/2
= 85 + (80/20) / 1920/2
= 85 + 4 / 960
= 89/960
= 0.0927
i.e 9.27 %
Thus pre tax cost of debt = 9.27%
2) After tax cost of debt = before tax cost of debt(1-tax rate)
= 9.27%(1-40%)
= 5.56 %
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