Question

Mojo Mining has a bond outstanding that sells for $1,049 and matures in 21 years. The bond pays semiannual coupons and has a coupon rate of 5.78 percent. The par value is $1,000. If the company's tax rate is 35 percent, what is the aftertax cost of debt?

Answer 1

Information provided:

Par value= future value= $1,000

Current price= present value= $1,049

Time= 21 years*2= 42 years

Coupon rate= 5.78%/2= 2.89%

Coupon payment= 0.0289*1,000= $28.90

Tax rate= 35%

The before tax cost of debt is calculated first.

The yield to maturity is computed to calculate the before tax cost of debt.

Enter the below in a financial calculator to compute the yield to maturity:

FV= 1,000

PV= -1,049

N= 42

PMT= 28.90

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 2.6937.

Therefore, the before tax cost of debt is 2.6937%*2= 5.3875%.

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

                                        = 5.3875%*(1 – 0.35)

                                        = 3.5015%    3.51%.

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