Question

Wasser, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 12 years to maturity that is quoted at 97 percent of face value. The issue makes semiannual payments and has a coupon rate of 10 percent. The tax rate is 25 percent. Enter your answers as a percent rounded to 3 decimal places, e.g., enter 32.161% as 32.161, not 0.32161. Hint. Solve for the YTM and adjust for taxes.

The after-tax cost of debt is ……………………… %

Hint: Use a financial calculator to solve for the yield to maturity of the bonds. Remember the negative sign on the price. Remember to divide/multiply by 2 when entering the PMT and N. Compute I and multiply by 2 to get the yield to maturity (ann). Then multiply by 1-taxrate to get the after-tax cost.

Answer 1

Information provided:

Face value= future value= $1,000

Current value= present value= 0.97*1,000= $970

Coupon rate= 10%/2= 5%

Coupon payment= 0.05*1,000= $50

Time= 12 years*2= 24 semi-annual periods

Tax rate= 25%

The after tax cost of debt is calculated by first computing the before tax cost of debt.

The yield to maturity is calculated to compute the before tax cost of debt.

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

FV= 1,000

PV= -970

N= 24

PMT= 50

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

The value obtained is 5.22.

Therefore, the before tax cost of debt is 5.22*2= 10.44%.

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

                                        = 10.44%*(1 – 0.25)

                                        = 7.83%.

In case of any query, kindly comment on the solution.