Question

You are analyzing the after-tax cost of debt for a firm. You know that the firm’s 12-year maturity, 12.50 percent semiannual coupon bonds are selling at a price of $1,212.11. These bonds are the only debt outstanding for the firm.

What is the current YTM of the bonds? (Round final answer to 2 decimal places, e.g. 15.25%.)

YTM

%

What is the after-tax cost of debt for this firm if it has a marginal tax rate of 34 percent? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

After-tax cost of debt

%

What is the current YTM of the bonds and after-tax cost of debt for this firm if the bonds are selling at par? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answers to 2 decimal places, e.g. 15.25%.)

YTM		%
After-tax cost of debt		%

Answer 1

Information provided:

Par value= future value= $1,000

Current price= present value= $1,212.11

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

Coupon rate= 12.50%/2= 6.25%

Coupon payment= 0.062.50*1,000= $62.50

The yield to maturity is calculated by entering the below in a financial calculator:

FV= 1,000

PV= -1,212.11

N= 24

PMT= 62.50

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

The value obtained is 4.75.

Therefore, the current yield to maturity is 4.75%*2= 9.50%.

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

                                       = 9.50%*(1 – 0.34)

                                     = 6.27%.

2.Information provided:

Par value= future value= $1,000

Current price= present value= $1,000

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

Coupon rate= 12.50%/2= 6.25%

Coupon payment= 0.062.50*1,000= $62.50

The yield to maturity is calculated by entering the below in a financial calculator:

FV= 1,000

PV= -1,000

N= 24

PMT= 62.50

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

The value obtained is 6.25.

Therefore, the current yield to maturity is 6.25%*2= 12.50%.

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

                                       = 12.50%*(1 – 0.34)

                                       = 8.25%.

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