Question

You are analyzing the after-tax cost of debt for a firm. You know that the firm’s 12-year maturity, 13.50 percent semiannual coupon bonds are selling at a price of $1,164.40. 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%.)

Answer 1

Information provided:

Par value= future value= $1,000

Current price= present value= $1,164.40

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

Coupon rate= 13.50%/2= 6.75%

Coupon payment= 0.06750*1,000= $67.50

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

FV= 1,000

PV= -1,164.40

N= 24

PMT= 67.50

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

The value obtained is 5.50

Therefore, the current yield to maturity is 5.50%*2= 11%.

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

                                       = 11%*(1 – 0.34)

                                       = 7.26%.

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= 13.50%/2= 6.75%

Coupon payment= 0.067.50*1,000= $67.50

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

FV= 1,000

PV= -1,000

N= 24

PMT= 67.50

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

The value obtained is 6.75.

Therefore, the current yield to maturity is 6.75%*2= 13.50%.

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

                                       = 13.50%*(1 – 0.34)

                                       = 8.91%.

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