Question

A firm has issued $45 million in long-term bonds that now have 12 years remaining until maturity. The bonds carry an 9% annual coupon and are selling in the market for $1220.74. The firm also has $50 million in market value of common stock. For cost of capital purposes, what portion of the firm is debt financed and what is the after-tax cost of debt, if the tax rate is 35%?

52.35% debt financed; 4.12% after-tax cost of debt

47.65% debt financed; 5.85% after-tax cost of debt

90.00% debt financed; 3.17% after-tax cost of debt

47.37% debt financed; 2.06% after-tax cost of debt

Answer 1

Weight of debt = debt par value*price to par/(debt par value*price to par+equity value)

=45*1.22074/(45*1.22074+50)=52.35%

K = N

Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =12

1220.74 =∑ [(9*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^12

k=1

YTM% = 6.32

After tax rate = YTM * (1-Tax rate)

After tax rate = 6.32 * (1-0.35)

After tax rate = 4.11