Question

Costly Corporation plans a new issue of bonds with a par value of $1000, a maturity of 21 years, and an annual coupon rate of 9.0%. Flotation costs associated with a new debt issue would equal 7.0% of the market value of the bonds. Currently, the appropriate discount rate for bonds of firms similar to Costly is 12.0%. The firm's marginal tax rate is 30%. What will the firm's true cost of debt be for this new bond issue?

Question 24 options:

	14.53%
	12.94%
	9.84%
	6.89%
	9.06%

Answer 1

K = N

Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =21

Bond Price =∑ [(9*1000/100)/(1 + 12/100)^k]     +   1000/(1 + 12/100)^21

k=1

Bond Price = 773.14

Cost of debt

K = N

Bond Price *(1-flotation %) =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =21

773.14*(1-0.07) =∑ [(9*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^21

k=1

YTM = 12.9426614365

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 12.9426614365*(1-0.3)

= 9.06