Question

P9-5 (similar to) The cost of debt Gronseth Drywall Systems, Inc., is in discussions with its investment bankers regarding the issuance of new bonds. The investment banker has informed the firm that different maturities will carry different coupon rates and sell at different prices. The firm must choose among several altera the bonds will have a $1,000 par value and flotation costs will be $35 per bond. The company is taxed at 28%. Use the approximation formula to calculate the after-tax cost of financing with the following alternative. (Click on the icon located on the top-right comer of the data table below in order to copy its contents into a spreadsheet) Coupon rate 8% Time to maturity 13 years Premium or discount - S280 The after-tax cost of financing using the approximation formula is 12 %. (Round to two decimal places.)

Answer 1

Before-tax cost of debt (using approximation formula) = [I + (1,000 -Nd)/n]/[(1,000+Nd)/2] where

I = annual interest in dollars = coupon rate*par value = 8%*1,000 - 80

Nd = net proceeds = par value - discount - flotation costs = 1,000 - 280 - 35 = 685

n = number of years to maturity = 13

Before-tax cost of debt = (80 + (1,000-685)/13)/((1,000+685)/2) = 12.37%

After-tax cost of debt = before-tax cost of debt*(1-Tax rate) = 12.37%*(1-28%) = 8.91%