Question

Additional Problems with Answers Problem 1 Cost of debt for a firm: You have been assigned the task of estimating the after-tax cost of debt for a firm as part of the process in determining the firm's cost of capital. After doing some checking, you find out that the firm's original 20-year 9.5% coupon bonds (paid semi-annually), currently have 14 years until they mature and are selling at a price of $1,100 each. You are also told that the investment bankers charge a commission of $25 per bond when new bonds are sold. If these bonds are the only debt outstanding for the firm, what is the after-tax cost of debt for this firm if the marginal tax rate for the firm is 34 percent?

Answer 1

Using financial calculator
N=14*2=28
PMT=9.5%*1000/2=47.5
FV=1000
PV=-1100+25=-1075
CPT I/Y=4.2850%

Pre-tax cost of debt=yield to maturity=2*4.2850%=8.5700%

After-tax cost of debt=Pre-tax cost of debt*(1-tax rate)=8.5700%*(1-34%)=5.6562%