Question

Advance, Inc. is trying to determine its cost of debt. The firm has issued bonds with face value of $1,000 which is currently selling at $1,050. This bond pays a coupon of 8 percent semiannually and has a maturity of 12 years. What is the pretax cost of debt? What is the after tax cost of debt, if the tax rate is 21 percent.

Answer 1

The Approximate Yield to Maturity Formula=[Coupon +  ( Face Value - Market Price) / Number of Years to Maturity ] / [( Face Value + Market Price)/2 ] *100

= ( $1000 * 4%) + ( $ 1000 - $ 1050) / 24 ] / [(1000 + 1050)/2] *100

= 37.9166667+ 1025*100

= 3.699186995%

Since this formula gives an approximate value, the financial calculators can be used alternatively.

where,

Par Value = $ 1,000

Market Price = $ 1,050

rate = 8% and

Maturity in Years = 12 Years

Compounding = Semi Annual

Hence the yield to maturity = 3.68%

Hence the company’s pretax cost of debt = 3.68%

The after tax cost of debt = Yield to Maturity * (1- tax Rate)

= 3.68% * ( 1- 21%)

= 2.9072%

Hence the correct answer is 2.91%