Question

Sheridan Ltd. has issued bonds that never require the principal amount to be repaid to investors. Correspondingly, Sheridan must make interest payments into the infinite future. If the bondholders receive annual payments of $77 and the current price of the bonds is $1,100.00. What is the pre-tax cost of this debt? (Round answer to 2 decimal places, e.g. 15.25%.) Pre-tax cost of debt e Textbook and Media What is the after-tax cost of this debt for Sheridan if the firm is in the 40 percent marginal tax rate? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.) After-tax cost of debt

Answer 1

This is an example of perpetuity where $77 annual payment would be made on a principal of $1100

PV of Perpetuity = – PV = Present Value D = Dividend or Coupon per period r = discount rate

1100 =

r = 77/1100

Pretax cost of debt, r = 7.00%

b) Post tax cost of debt = Pretax cost of debt * (1 - Tax rate)

Post tax cost of debt = 7% * (1 - 40%) = 4.20%