Question

Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of 3.62 percent, a par value of $1,000 per bond, matures in 8 years, has a total face value of $4.2 million, and is quoted at 103 percent of face value. The second issue has a coupon rate of 6.42 percent, a par value of $1,000 per bond, matures in 24 years, has a total face value of $8.5 million, and is quoted at 91 percent of face value. Both bonds pay interest semiannually. The company's tax rate is 40 percent. What is the firm's weighted average aftertax cost of debt? 3.44% 4.62% 5.77% 3.29% 3.12%

Answer 1

The correct answer is the first option 3.44%

Please see the table below for sequential calculations. Please be guided by the second column that explains how each row has been calculated.

Parameter	Linkage	First Bond	Second Bond
Coupon Rate	A	3.62%	6.42%
Par Value	B	1,000	1,000
Years to maturity	C	8	24
Frequency in a year	D	2	2
Total Face Value ($ mn)	E	4.20	8.50
Nos. of bond	F = E x 106 / B	4,200	8,500
Price of 1 bond	G	103%	91%
Price of 1 bond	H = G x B	1,030	910
Market Value of Bond	I = H x F	4.33	7.74
Weight	J	4.33 / (4.33 + 7.74) = 35.87%	1 – 35.87% = 64.13%
Pre tax yield	K = 2 x RATE (D x C, A x B / D, -H, B)	3.19%	7.21%

Weighted average yield = 35.87% x 3.19% + 64.13% x 7.21% = 5.77%

Tax rate. T = 40%

the firm's weighted average aftertax cost of debt = 5.77% x (1 – T) = 5.77% x (1 – 40%) = 3.44%

Hence, please choose the first option showing 3.44%