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Firm PooX has $2 million in outstanding long-term debt (face value), the current quote = $980, coupon rate of 9%, semiannual coupons, 10 years to maturity, and the tax rate = 40%
Firm PooX has $2 million in outstanding long-term debt (face value), the current quote = $980, coupon rate of 9%, semiannual coupons, 10 years to maturity, and the tax rate = 40%. It also has short-term liabilities (6 months) with a market value of $500,000. If the current value of the equity is $1million with a book value of $1.5 million, what is the after-tax required rate of return on the debt?
5.59%
2.79%
4.66%
9.31%
None of the above
Expert Solution
Use RATE function in EXCEL to find the pre tax cost of debt
=RATE(nper,pmt,pv,fv,type)
Please remember that the payments rae semi-annual
nper=10 years*2=20
pmt=semi-annaul coupon=(coupon rate*face value)/2=(9%*1000)/2=90/2=45
pv=980
fv=1000
=RATE(20,45,-980,1000,0)=4.66%
pre tax cost of debt=2*4.66%=9.31%
after tax cost of debt=pre tax cost of debt*(1-tax rate)=9.31%*(1-40%)=5.59%
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