Question

Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of 3.48 percent, a par value of $1,000 per bond, matures in 7 years, has a total face value of $3.5 million, and is quoted at 108 percent of face value. The second issue has a coupon rate of 5.86 percent, a par value of $2,000 per bond, matures in 20 years, has a total face value of $7.8 million, and is quoted at 94 percent of face value. Both bonds pay interest semiannually. The company's tax rate is 39 percent. What is the firm's weighted average aftertax cost of debt?

Answers:

2.48%

4.98%

4.01%

2.63%

2.95%

Answer 1

weighted average aftertax cost of debt = (weight of Bond 1 * YTM of Bond 1) + (weight of Bond 2 * YTM of Bond 2)

weight of each bond = market value of each bond / total market value of both bonds

YTM of each bond is calculated as below :

YTM is calculated using RATE function in Excel with these inputs :

nper = (years to maturity * 2)

pmt =  (semiannual coupon payment = face value * annual coupon rate / 2. This is a positive figure as it is an inflow to the bondholder)

pv = -1000 * price as % of par (This is a negative figure as it is an outflow to the buyer of the bond)

fv = 1000 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)

The RATE calculated is the semiannual YTM. To calculate the annual YTM, we multiply by 2.

weighted average aftertax cost of debt = 4.98%