Question

Cost of debt using the approximation formula For the following $1,000-par-value bond, assuming annual interest payment and a 25% tax rate, calculate the after-tax cost to maturity using the approximation formula. Life 5 years Underwriting fee $15 Discount ( - ) or premium (+) $20 Coupon interest rate 7% The after-tax cost of financing using the approximation formula is %. (Round to two decimal places.)

Answer 1

Bond Par Value = $1,000

Bond Price = 1,000 + 20 - 15 = $1,005

Coupon Payment = 0.07(1,000) = $70

Time Period = 5 years

By Approximation Formula,

YTM = [C + (F - P)/n]/[(F + P)/2]

YTM = [70 + (1,000 - 1,005)/5]/[2,005/2]

YTM = 0.0688

YTM = 6.88%

After-tax cost of financing = (1 - 0.25)(0.0688)

After-tax cost of financing = 5.16%