Question

3. Cost of debt Aa Aa The is the interest rate that a firm pays on any new debt financing. Omni Consumer Products Company (OCP) can borrow funds at an interest rate of 11.10% for a period of five years. Its marginal federal-plus-state tax rate is 40%. OCP's after-tax cost of debt is (rounded to two decimal places). At the present time, Omni Consumer Products Company (OCP) has 10-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,092.79 per bond, carry a coupon rate of 11%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 40%. If OCP wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? 0 5.71% O 6.85% 0 6.57% 05.14%

Answer 1

a. The before tax cost of debt is the interest rate that a firm pays on any new debt financing

b. OCP's after tax cost of debt is computed as shown below:

= 11.10% (1 - 0.40)

= 6.66%

c. The after tax cost of debt is computed as follows:

First we will compute YTM by plugging the below figures in the financial calculator as follows:

PV = - 1,092.79

FV = 1,000

N = 10

PMT = 11% x 1,000

= 110

Then press CPT and then press I/Y, which will give I/Y as

= 9.52% Approximately

So the after tax cost of debt will be:

= 9.52% x (1 - 0.4 )

= 5.71% Approximately

So the correct answer is option of 5.71%

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