Question

The cost of debt Gronseth Drywall Systems, Inc., is in discussions with its investment bankers regarding the issuance of new bonds. The investment banker has informed the firm that different maturities will carry different coupon rates and sell at different prices. The firm must choose among several alternatives. In each case, the bonds will have a $1,000 par value and flotation costs will be $40 per bond. The company is taxed at 40%. Use the approximation formula to calculate the after-tax cost of financing with the following alternative. (Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Coupon rate 6% Time to maturity 17 years Premium or discount $180 The after-tax cost of financing using the approximation formula is %. (Round to two decimal places.)

Answer 1

Coupon rate is 6%

Face value is 1000

Current value is (1000+180)=1180

Net proceeds after flotation costs = 1180-40=1140

Cost of debt is yield to maturity on the bonds

Ytm = c+(fv-np)/n/(fv+np)/2

Where c is coupon

Fv is face value

Np is net proceeds

N is no of years

=( 60+(1000-1140)/17)/(1000+1140)/2

= 4.8378%

Given tax rate is 40%

After tax cost of debt is 4.8378(1-0.4) = 2.90268%