Question

Filer Manufacturing has 4500000 shares of common stock outstanding. The current share price is $69.11, and the book value per share is $9.62. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $53000000, has a 0.05 coupon, matures in 10 years and sells for 83 percent of par. The second issue has a face value of $58000000, has a 0.06 coupon, matures in 20 years, and sells for 92 percent of par.

The most recent dividend was $1.09 and the dividend growth rate is 0.03. Assume that the overall cost of debt is the weighted average of that implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 0.22.

What is Filer's aftertax cost of debt? Enter the answer with 4 decimals (e.g. 0.2345)

Answer 1

First bond:

Face value = $53,000,000

Price = 83% of 53,000,000 = 43,990,000

Coupon = 0.05 * 53,000,000 = 2,650,000

Number of years = 10

Yield to maturity using a financial calculator = 0.0747 or 7.47%

(Keys to use in a financial calculator: FV = 53,000,000, PV = -43,990,000, PMT = 2,650,000, N = 10, CPT I/Y)

Second issue:

Face value = $58,000,000

Price = 92% of 58,000,000 = 53,360,000

Coupon = 0.06 * 58,000,000 = 3,480,000

Number of years = 20

Yield to maturity using a financial calculator = 0.0674 or 6.74%

(Keys to use in a financial calculator: FV = 58,000,000, PV = -53,360,000, PMT = 3,480,000, N = 20, CPT I/Y)

Total market value of debt = 53,360,000 + 43,990,000 = 97,350,000

Weight of 1st issue = 53,360,000 / 97,350,000 = 0.5481

Weight of 2nd issue = 43,990,000 / 97,350,000 = 0.4519

Weighted average before tax cost of debt = 0.5481 * 0.0747 + 0.4519 * 0.0674

Weighted average before tax cost of debt = 0.040943 + 0.030458

Weighted average before tax cost of debt = 0.071401

After tax cost of debt = 0.071401 ( 1 - 0.22)

After tax cost of debt = 0.0557