Question

The is the interest rate that a firm pays on any new debt financing. Wat after-tax cost of debt VPC) can borrow funds at an interest rate of 10.20% for a period of five years. Its marginal federal-plus-state tax rate is 25% before-tax cost of debt Pebt is __ (rounded to two decimal places). At the present time, Water and Power Company (WPC) has 15-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,329.55 per bond, carry a coupon rate of 12%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 25%. If WPC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? (Note: Round your YTM rate to two decimal place.) 7.31% 7.00% 5.48% 6.09%

Answer 1

a)
The before tax cost of debt is the interest rate that a firm pays on any new debt financing.

b)
After tax cost of debt = Pre tax cost * (1 - tax rate)
= 10.20 * (1 - 0.25)
= 10.20 * 0.75
= 7.65%

c)
The pretax cost of debt is calculated by using the following excel formula:
=RATE(nper,pmt,pv,fv)
=RATE(15,120,-1329.55,1000)
= 8.12%
After tax cost of debt = 8.12 * (1 - 0.25)
= 8.12 * 0.75
= 6.09%

d)
rp is the symbol that represents the cost of preferred stock in the weighted average cost of capital equation.

e)
Weight on debt = 2.7 million / (2.7 million + 2.5 million + 1.8 million)
= $2.7 million / $7 million
= 0.39