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​(Cost of debt​) Sincere Stationery Corporation needs to raise $750,000 to improve its manufacturing plant. It...

​(Cost of debt​) Sincere Stationery Corporation needs to raise $750,000 to improve its manufacturing plant. It has decided to issue a $1,000 par value bond with an annual coupon rate of 15 percent and a maturity of 18 years. The investors require a rate of return of 9 percent.

a. Compute the market value of the bonds.

b. What will the net price be if flotation costs are

14 percent of the market​ price?

c. How many bonds will the firm have to issue to receive the needed​ funds?

d. What is the​ firm's after-tax cost of debt if its average tax rate is 25 percent and its marginal tax rate is

36 ​percent?

a. What is the market value of the​ bonds?

​$ ​(Round to the nearest​ cent.)

b. What will the net price be if flotation costs are 14 percent of the market​ price?

​$ (Round to the nearest​ cent.)

c. How many bonds will the firm have to issue to receive the needed​ funds?

bonds (Round to the nearest whole​ number.)

d. What is the​ firm's after-tax cost of debt if its average tax rate is 25 percent and its marginal tax rate is 36 percent?

% ​(Round to two decimal​ places.)

Solutions

Expert Solution

a]

Price of a bond is the present value of its cash flows. The cash flows are the coupon payments and the face value receivable on maturity

Price of bond is calculated using PV function in Excel :

rate = 9% (YTM of bonds = required return)

nper = 18 (Years remaining until maturity with 1 coupon payment each year)

pmt = 1000 * 15% (annual coupon payment = face value * coupon rate)

fv = 1000 (face value receivable on maturity)

PV is calculated to be $1,525.34

b]

net price = market price * (1 - flotation cost %)

net price = $1,525.34 * (1 - 14%)

net price = $1,311.79

c]

Number of bonds to issue = total funds to raise / net price

Number of bonds to issue = $750,000 / $1,311.79

Number of bonds to issue = 571.74

As fractional bonds cannot be sold, this is rounded off to 572

d]

after-tax cost of debt = yield of bonds * (1 - marginal tax rate)

The marginal tax rate is used because it is the tax rate paid on each dollar of additional income. As these are new bonds, the marginal tax rate is more appropriate than the average tax rate

after-tax cost of debt = 9% * (1 - 36%)

after-tax cost of debt = 5.76%

jeff jeffy answered 2 years ago
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