Question

Olympic Sports has two issues of debt outstanding. One is a 7% coupon bond wit ha face value of $26 million, a maturity on 15 years, and a yield of 8%. The coupons are paid annually. The other bond issue has a maturity of 20 years, with coupons also paid annually, and a coupon rate of 8%. The face value of the issue is $31 million, and the issue sells for 95% of par value. The firms tax rate is 35%.

A). What is the before-tax cost of debt for Olympic?

B). What is Olympic's after-tax cost of debt?

(For all the requirements, do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

Answer 1

Answer : (A.) Calculation of Before Tax Cost of Debt

Before Tax Cost of Debt 1 = 8%

Before Tax cost of Debt 2 can be calculated using Rate function :

=RATE(nper,pmt,pv,fv)

where nper is the years to maturity i.e 20

pmt is the periodic payment i.e 80 (1000 * 8%)

pv is the Market Price i.e 950 (1000 * 95%)

Assuming Par value of 1000

fv is the par value i.e 1000

=RATE(20,80,-950,1000)

Therefore Before tax Yield to Maturity is 8.5295%

Calculation of Market Value of Bonds :

Market Value of Bond = [Coupon * PVAF @8% for 15 years ] + [Par Value * PVF @8% for 15th year]

= [(1000 * 7%) * 8.55947868746] + [1000 * 0.31524170492]

= 914.405213042

Therefore It is selling at 91.4405213042% of Par value

Market Value = 26 million * 91.4405213042%

= 23.774535539 million

Market Value of Bond 2 = 31 million * 95% = 29.45 million

Total Market Value = 23.774535539 + 29.45 = 53.224535539 million

Therefore

(a.) Before Tax Cost of Debt = [8% * (23.774535539 / 53.224535539)] + [8.5295% * (29.45 / 53.224535539)]

=3.57347006192% + 4.72%

= 8.29%

(b.) After Tax cost of Debt = 8.29% * (1 - 0.35)

= 5.39%