Question

1. LL Inc.’s currently outstanding 15% coupon bonds have a yield to maturity of 8.6%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 30%, what is LL’s after tax cost of debt?

Please - no rounding

Answer 1

The firms pay periodic interest at coupon rate and face value at maturity. Yield to maturity is the rate at which this payments are discounted to calculate price of bond. Where YTM is equal to coupon rate of bond, Bond will be selling at par value only.

Now LL believes it could issue new bonds at par that would provide a similar yield to maturity, thus once can say that in this case coupon rate will be equal to YTM. YTM is 8.6%
Thus coupon rate on new bonds = 8.6%

After tax cost of debt = Coupon rate(1-tax rate)
=8.6%(1-30%)
=8.6%(1-0.3)
=8.6%(0.7)
=6.02%