Question

Filer Manufacturing has 4100000 shares of common stock outstanding. The current share price is $55.99, and the book value per share is $5.70. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $70000000, has a 0.05 coupon, matures in 10 years and sells for 83 percent of par. The second issue has a face value of $65000000, has a 0.06 coupon, matures in 20 years, and sells for 92 percent of par.

The most recent dividend was $2.67 and the dividend growth rate is 0.06. Assume that the overall cost of debt is the weighted average of that implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 0.24.

What is Filer's aftertax cost of debt? Enter the answer with 4 decimals (e.g. 0.2345)

Answer 1

Bond 1:

Face value = 70,000,000

Price of bond = 0.83 * 70,000,000 = 58,100,000

Coupon payments = 0.05 * 70,000,000 = 3,500,000 / 2 = 1,750,000

Number of periods = 10 * 2 = 20

Cost of debt using a financial calculator = 7.44016%

Keys to use in a financial calculator: 2nd I/Y 2, FV 70,000,000, PV 58,100,000, N 20, PMT 1,750,000, CPT I/Y

Bond 2:

Face value = 65,000,000

Price of bond = 0.92 * 65,000,000 = 59,800,000

Coupon payments = 0.06 * 65,000,000 = 3,900,000 / 2 = 1,950,000

Number of periods = 20 * 2 = 40

Cost of debt using a financial calculator = 6.73385%

Keys to use in a financial calculator: 2nd I/Y 2, FV 65,000,000, PV 59,800,000, N 40, PMT 1,950,000, CPT I/Y

Total market value of bond = 59,800,000 + 58,100,000 = 117,900,000

Weight of bond 1 = 58,100,000 / 117,900,000 = 0.4928

Weight of bond 2 = 59,800,000 / 117,900,000 = 0.5072

Weighted average before tax cost of debt = 0.4928 * 0.0744016 + 0.5072 * 0.0673385

Weighted average before tax cost of debt = 0.036665 + 0.034154

Weighted average before tax cost of debt = 0.070819 or 7.0819%

After tax cost if debt = 0.070819 ( 1 - 0.24 )

After tax cost if debt = 0.053822 or 5.3822%