Question

At the present time, Omni Consumer Products Company (OCP) has 15-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,555.38 per bond, carry a coupon rate of 11%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 45%. If OCP wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? O O O O 2.71% 3.46% 3.61% 3.01%

Answer 1

K = N

Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =15

1555.38 =∑ [(11*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^15

k=1

YTM% = 5.48

After tax rate = YTM * (1-Tax rate)

After tax rate = 5.48 * (1-0.45)

After tax rate = 3.01