Question

In: Finance

Suppose that Coca-Cola is considering a new capital budgeting project. The project will use debt with...

Suppose that Coca-Cola is considering a new capital budgeting project. The project will use debt with maturities of 15 years. To determine the cost of debt for the project, an analyst at Coca-Cola looks at currently trading Coca-Cola debt. The analyst is looking at a Coke bond that trades today for $984.00. This bond has an annual coupon rate of 8.00%, face value of $1,000, and will mature in 15 years. The marginal tax rate for Coca-Cola is 38.00%.

What is the after-tax cost of debt for Coca-Cola?

Answer format: Percentage Round to: 2 decimal places (Example: 9.24%, % sign required. Will accept decimal format rounded to 4 decimal places (ex: 0.0924))

Solutions

Expert Solution

The after-tax cost of debt for Coca-Cola

  • The after-tax cost of debt for Coca-Cola is the after-tax Yield to maturity (YTM) of the Bond
  • The Yield to maturity (YTM) of the Bond is the discount rate at which the Bond’s price equals to the present value of the coupon payments plus the present value of the Face Value/Par Value
  • The Yield to maturity of (YTM) of the Bond is the estimated annual rate of return expected by the bondholders for the bond assuming that the they hold the Bonds until it’s maturity period/date.
  • The Yield to maturity of (YTM) of the Bond is calculated using financial calculator as follows (Normally, the YTM is calculated either using EXCEL Functions or by using Financial Calculator)

Variables

Financial Calculator Keys

Figure

Par Value/Face Value of the Bond [$1,000]

FV

1,000

Coupon Amount [$1,000 x 8.00%]

PMT

80

Market Interest Rate or Yield to maturity on the Bond

1/Y

?

Maturity Period/Time to Maturity [15 Years]

N

15

Bond Price/Current Market Price of the Bond

PV

-984

We need to set the above figures into the financial calculator to find out the Yield to Maturity of the Bond. After entering the above keys in the financial calculator, we get the annual yield to maturity on the bond (1/Y) = 8.19%

Therefore, the After-tax cost of debt = Yield to maturity on the bond x (1 – Tax Rate)

= 8.19% x (1 – 0.38)

= 8.19% x 0.62

= 5.08%

“Hence, the after-tax cost of debt for Coca-Cola will be 5.08%”

jeff jeffy answered 3 months ago
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