Avicorp has a $10.8 million debt issue outstanding, with a 6.1% coupon rate. The debt has semi-annual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 93% of par value.
a. What is Avicorp's pre-tax cost of debt? Note: Compute the effective annual return. ROUND TO 4 DECIMAL PLACES
b. If Avicorp faces a 40% tax rate, what is its after-tax cost of debt? ROUND TO 4 DECIMAL PLACES
Note: Assume that the firm will always be able to utilize its full interest tax shield.
a). To find the pre-tax cost of debt, we need to put the following values in the financial calculator:
N = 5*2 = 10;
PV = -0.93*1000 = -930;
PMT = (6.1%/2) * 1000 = $30.50;
FV = 1000;
Press CPT, then I/Y, which gives us 3.91
Periodic Rate = 3.91%
Pre-tax cost of debt = Periodic Rate * No. of compounding periods in a year
= 3.91% * 2 = 7.82%
b). After-tax cost of debt = Pre-tax cost of debt * (1 - t) = 7.82% * (1 - 0.40) = 4.69%
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