Question

​(Cost of debt​) Carraway Seed Company is issuing a $1,000 par value bond that pays 11 percent annual interest and matures in 11 years. Investors are willing to pay ​$965 for the bond. Flotation costs will be 13 percent of market value. The company is in a 30 percent tax bracket. What will be the​ firm's after-tax cost of debt on the​bond?

The​ firm's after-tax cost of debt on the bond will be ??

Answer 1

Solution:
	The​ firm's after-tax cost of debt on the bond will be	9.75%
Working Notes:
	Since the coupon rate is specifically given that annual payment so it will be considered annual coupon paying bond otherwise if only coupon rate would have given then it will be assumed semi annual . Now it is annual coupon paying bond and below computation is also is done for the same way.
	No. of period = years to maturity x no. of coupon in a year = 11 x 1 =nper = N = 11
	Face value of bond = FV= $1,000
	Net Price of the bond = PV = market value x ( 1 - floatation rate) = 965 x ( 1- 0.13) = 965 x 0.87 = -839.55
	Annual Coupon amount = PMT = coupon rate x face value = 11% x $1,000 = $110
	For calculation YTM by excel
	type above data in below format
	=RATE(N,pmt,PV,FV)
	=RATE(11,110,-839.55,1000)
	0.139345715
	=13.9345715%
	The​ firm's after-tax cost of debt
	= annual YTM x ( 1 - tax rate)
	= 13.9345715% x ( 1 - 0.30)
	= 9.75420005%
	=9.75%
Please feel free to ask if anything about above solution in comment section of the question.