Fastest Company has a debt rating of A and a tax rate of 35%. The current...

Fastest Company has a debt rating of A and a tax rate of 35%. The current long term government bond yield is 2.1%. Suppose the typical spread between long-term government yields and A-rated firms is about 1.6%. Estimate Fastest Company's after-tax cost of debt.

How would your answer change if Fastest Company's debt rating deteriorated to BBB and the typical spread between long-term government yields and BBB-rated firms was 2.7%?

The after tax cost of debt in the first case is:

The after tax cost of debt in the second case is:

Expert Solution

1)

Yield to maturity = 2.1% + 1.6% = 3.7%

after tax cost of debt in the first case = 0.037 (1 - 0.35)

after tax cost of debt in the first case = 0.02405 or 2.405%

2)

Yield to maturity = 2.1% + 2.7% = 4.8%

after tax cost of debt in the first case = 0.048 (1 - 0.35)

after tax cost of debt in the second case = 0.0312 or 3.12%

jeff jeffy answered 2 years ago

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