Question

Use the following information to answer the next five questions: Consider the after-tax cash flows below from a project that is being considered by Despondus Corporation. Since the project is an extension of the firm's current business, it carries the same risk as the overall firm. 1 Year 0 1 2 3 4 5 Cash Flow $479,000 $103,000 $67,000 $107,000 $92,000 $102,000 Despondus Corporation's common stock is currently priced at $124.05, and there are 713,000,000 shares outstanding. A dividend of $4.16 per share was just paid, and dividends are expected to grow at a constant rate of 5.48% per year. The company has 8,120,000 bonds outstanding that mature in 15 years and are currently priced at $943 per bond. The coupon rate is 11.35%, and the bonds make semiannual interest payments. The company's tax rate is 33%.

Answer 1

Compute the semi-annual interest, using the equation as shown below:

Semi-annual interest = Face value*Rate of interest/2

                                  = $1,000*11.35%/2

                                  = $56.75

Hence, the semi-annual interest is $56.75.

Compute the semi-annual yield to maturity (YTM), using the equation as shown below:

Semi-annual YTM = [Semi-annual interest + {(Redemption value – Net proceeds)/ Maturity period}]/ {(Redemption value + Net proceeds)/ 2}

                                = [$56.75 + {($1,000 – $943)/ 30}]/ {($1,000 + $943)/ 2}

                                = ($56.75 + $1.90)/ $971.50

                                = 6.037056098%

Hence, the semi-annual YTM is 6.037056098%.

Compute the yield to maturity (YTM), using the equation as shown below:

YTM = Semi-annual YTM*2

          = 6.037056098%*2

          = 12.074112196%

Hence, the YTM or cost of debt before tax is 12.074112196%.

Compute the after-tax cost of debt, using the equation as shown below:

After-tax cost of debt = Cost of debt before tax*(1 – Tax rate)

                                    = 12.074112196%*(1 – 0.33)

                                    = 8.0896551714%

Hence, the after-tax cost of debt is 8.0896551714%.