Question

6 Vibrato 1022 Co had a bond issue outstanding that matures in 14 vears. The $1.000 faces & value bonds page interset smei annually.. Currently, the bands are quoted at 96.5% Of face value and carry a 7% coupon. What is the firms after tax cost of debt If the tax rate is 22% A 7.4100 6 6.11% () 8.73 % D) 7.02% c) 5.78% 2 it a coporation carns a rate of return on its invested capital that is equal to or lomer than the market required Rate of return on that invested capital, the stock price will decrease in value A True B false 3 For a profitable corporation, the after ton cost of debt must always be higher o than the firms interset rate paid on its debt l assume the firm pays income taxes, don't assume tax - loss carry forward) - A True B false

Answer 1

Answer 1:

Correct answer is:

e. 5.78%

Explanation:

Par value = $1000

Price = 1000 * 96.5% = $965

Semiannual coupon = 1000 * 7% / 2 = $35

Number of semiannual periods = 14 * 2 = 28

Semiannual YTM = RATE(nper, pmt, pv, fv, type) = RATE(28, 35, -965, 1000, 0) = 3.7029%

Before tax YTM = 3.7029% * 2 = 7.41%

After tax cost of debt = 7.41% * (1 - 22%) = 5.78%

Hence option e is correct and other options a, b, c and d are incorrect.

Answer 2:

Statement is:

A) True

Explanation:

If rate of return on invested capital =< Market required rate of return, share value is expected to remain same or decrease.

Hence the statement is true.

Answer 3:

Statement is:

B) False

Explanation:

After tax cost of debt = Before tax cost of debt * (1 - Tax rate)

So, if a first pays income tax, its after tax cost of debt < before tax cost of debt.

Hence the statement is false.