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Frank's Cargo Corp has 100,000 outstanding bonds paying $30 twice a year. Today, the bonds sell...

Frank's Cargo Corp has 100,000 outstanding bonds paying $30 twice a year. Today, the bonds sell for $900 and will mature in five years. If the market rate is 12%, the risk-free rate is 2%, and the marginal tax rate is 30%, what is the cost of debt capital for Frank's Cargo Corp?

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Expert Solution

Cost of debt (or bonds) refers to the yield to maturity. We are provided with the following information:
Present value=$900
Semiannual coupon payment=$30
Time period=5 years
As the coupon payment is made semiannually, the number of periods=5*2=10
Suppose the face value of the bond be $1000
Now, we can determine the yield to maturity (YTM) using excel as follows:

As the present value is a cash outflow, we have taken it as negative in excel.

The annualized yield to maturity (YTM) is the pretax cost of debt.
After tax cost of debt=8.50%*(1-Tax rate)
=8.50%*(1-30%)
=8.50%*0.7=0.0595 or 5.95%

Answer: The pretax cost of debt is 8.5% and after tax cost of debt is 5.95%

jeff jeffy answered 4 months ago
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