Question

6.4%, paid semi-annually

Suppose a company issues 10 year debt with a par value of $1,000 and a coupon rate of 6.4%, paid semi-ar The issue price will be $980. The tax rate is 30%. If the flotation costs are 4.5% of the issue proceeds, For the avoidance of doubt, assume the flotation costs are more than de minimis. a. What is the company's pre-tax cost of debt? a. What is the company's after-tax cost of debt?

Answer 1

Ans:

C = 6.4% of 1000 = 64

Net Proceed (NP) = 980 - 980*4.5% = $935.9   (Here to calculate net proceed, we have subtracted 4.5 % flotation cost from the issue price)

Maturity Value = $ 1000

Maturity Period = 10 Years

Cost of Debt (Kd) = [ C + (MV-NP)/n] / (MV+NP)/2

                         = [ 64 + (1000-935.9)/10]/ (1000+935.9)/2 = 7.27%

Cost of Debt (Before Tax) = 7.27 %

Cost of Debt after tax = [ C(1-t) + (MV-NP)/n]/ (MV+NP)/2                                          (where t is the tax rate i.e. 30%)

                                = [ 64* (1-0.70) + (1000-935.9)/10]/ (1000+935.9)/2 = 5.29%

Cost of Debt (After Tax) = 5.29%