Question

Mojo Mining has a bond outstanding that sells for $1,046 and matures in 20 years. The bond pays semiannual coupons and has a coupon rate of 5.7 percent. The par value is $1,000. If the company's tax rate is 40 percent, what is the aftertax cost of debt?

5.42%

3.00%

3.44%

3.19%

5.06%

Answer 1

Information provided:

Par value= future value= $1,000

Current price= present value= $1,046

Time= 20 years*2= 40 semi-annual periods

Coupon rate= 5.7%/2= 2.85%

Coupon payment= 0.0285*1,000= $28.50

Tax rate= 40%

The question is solved by first computing the before tax cost of debt.

Enter the below in a financial calculator to calculate the yield to maturity:

FV= 1,000

PV= -1,046

N= 40

PMT= 28.50

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 2.6617

Therefore, the before tax cost of debt is 2.6617%*2= 5.3235%.

After tax cost of debt= before tax cost of debt*(1 – tax rate)

                                        = 5.3235%*(1 – 0.40)   

                                        = 3.1941% 3.19%

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