Question

CBA Corporation's outstanding bonds are selling at $950. The bonds have a face value of $1000, annual coupon rate of 8.5%, and 10 years until maturity. CBA is planning to sell new bonds to raise additional capital. New bonds will be as risky as the old bonds. However, the firm will incur flotation costs of 10% on new bond issue.

A. Calculate investors required rate of return on new bonds.

B. Calculate the before-tax cost of (new) debt.

Answer 1

A

Cost of debt

K = N

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

k=1

K =10

950 =∑ [(8.5*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^10

k=1

YTM = 9.29

B

Cost of debt

K = N

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

k=1

K =10

950*(1-0.1) =∑ [(8.5*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^10

k=1

YTM = 10.96