The Royal Inc. is currently in the business of making kitchen cabinets. It has $400,000 in outstanding bonds with a coupon rate of 8% and a yield-to-maturity of 7.5%.

The Royal Inc. is currently in the business of making kitchen cabinets. It has $400,000 in outstanding bonds with a coupon rate of 8% and a yield-to-maturity of 7.5%. The company is seeking additional financing so it can start a new venture, which involves the sales and installation of patio rooms, including spas and hot tubs. Its biggest competitor, who specializes solely in patio rooms, has $600,000 in outstanding bonds with a 9% coupon rate and an 11% yield-to-maturity. Royal's marginal tax rate is 35% and the competitor's marginal tax rate is 34%. What after-tax rate cost of debt should the Royal Inc. use in its WACC calculation? Which source of capital structure is likely to provide more tax-related benefit? (Show detailed calculations)

Expert Solution

Answer a)

We will consider the marginal tax rate of the Royal Inc only but the YTM will considered similar to the YTM of the competitor.

Therefore after tax Cost of Debt that will be used for WACC will be

= YTM * (1-taxes)

= 11% * (1-0.35)

= 7.15%

Answer b)

Debt will obviously provide the cheaper cost to the co as the interest on Debt is a tax dedectible Source of finance. While the Dividends are not tax deductible as they are appropriation of profits not charge against profits. Equity is expensive.

jeff jeffy answered 2 years ago

ABC Inc.’s currently outstanding 9% coupon bonds have a yield to maturity of 8%. ABC believes...

ABC Inc.’s currently outstanding 9% coupon bonds have a yield to maturity of 8%. ABC believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 30%, what is ABC’s after-tax cost of debt, rd? Also, ABC can issue perpetual preferred stock at a price of $50 a share with an annual dividend of $3.00 a share. What is the company’s cost of preferred stock, rps? Besides, ABC has...

BEEber Inc. currently has 10,000 bonds outstanding. The bonds have a coupon rate of 8%, paid...

BEEber Inc. currently has 10,000 bonds outstanding. The bonds have a coupon rate of 8%, paid semi-annually, mature in 10 years, and are trading at $985 each. BEEber’s common stock currently sells for $20 per share and there are 750,000 shares outstanding. The risk-free rate is 4.5%, the expected return on the market is 15%, and BEEber’s beta is equal to 2.0. The corporate tax rate is 40%. What is BEEber’s WAC?

LL Incorporated's currently outstanding 10% coupon bonds have a yield to maturity of 7.2%.

FIN - 650 --- Problem 9-02 (After-Tax Cost of Debt)LL Incorporated's currently outstanding 10% coupon bonds have a yield to maturity of 7.2%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 25%, what is LL's after-tax cost of debt? Round your answer to two decimal places.________%

A corporation has 10,000 bonds outstanding with a 6% annual coupon rate, 8 years to maturity,...

A corporation has 10,000 bonds outstanding with a 6% annual coupon rate, 8 years to maturity, a $1,000 face value, and a $1,100 market price. The company’s 500,000 shares of common stock sell for $25 per share and have a beta of 1.5. The risk free rate is 4%, and the expected return on the market is 12%. The company recently paid a dividend of $2.0 per share on the common stock. The expected dividend growth rate is 7%. The...

- A corporation has 10,000 bonds outstanding with 6% annual coupon rate, 8 years to maturity,...

- A corporation has 10,000 bonds outstanding with 6% annual coupon rate, 8 years to maturity, $1,000 face value, and $1,100 market price. - The company’s 500,000 shares of common stock sell for $25 per share and have a beta of 1.5. The risk-free rate is 4%, and the market risk premium is 8%. - The company’s 100,000 shares of preferred stock pay a $3 annual dividend, and sell for $30 per share. - Assuming a 40% tax rate, what...

The yield to maturity on 1-year zero-coupon bonds is currently 6.5%; the yield to maturity on...

The yield to maturity on 1-year zero-coupon bonds is currently 6.5%; the yield to maturity on 2-year zeros is 7.5%. The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon of 8.5%. The face value of the bond is $1,000. At what price will the bond sell? What will the yield to maturity on the bond be? If the expectations theory of the yield curve is correct, what is the market expectation...

The Heuser company’s currently outstanding 10% coupon bonds have a yield to maturity of 12%. Heuser...

The Heuser company’s currently outstanding 10% coupon bonds have a yield to maturity of 12%. Heuser believes it could issue at par new bonds that would provide a similar yield maturity. The marginal tax rate of Heuse is 35%. Required: Calculate the after-tax cost of debt of Heuser. Why debt is generally considered cheaper than equity? Explain in less than 6 lines. Would you borrow money if interest rate is significantly lower than ROA? (Either state yes or no). Explain...

Epson has one bond outstanding with a yield to maturity of 5% and a coupon rate...

Epson has one bond outstanding with a yield to maturity of 5% and a coupon rate of 8%. The company has no preferred stock. Epson's beta is 0.9, the risk-free rate is 0.6% and the expected market risk premium is 6%. Epson has a target debt/equity ratio of 0.7 and a marginal tax rate of 34%. 1. What is Epson's (pre-tax) cost of debt? 2. What is Epson's cost of equity? 3. What is Epson's capital structure weight for equity,...

A) The coupon rate on a debt issue is 8%. If the yield to maturity on...

A) The coupon rate on a debt issue is 8%. If the yield to maturity on the debt is 9%, what is the after-tax cost of debt in the weighted average cost of capital if the firm's tax rate is 41%? a. 3.96% b. 5.31% c. 7.46% d. 6.66% B) Expected cash dividends are $5.00, the dividend yield is 5%, flotation costs are 8% of price, and the growth rate is 4%. Compute the approximate cost of new common stock....

CURRENT YIELD, CAPITAL GAINS YIELD, AND YIELD TO MATURITY Hooper Printing Inc. has bonds outstanding with...

CURRENT YIELD, CAPITAL GAINS YIELD, AND YIELD TO MATURITY Hooper Printing Inc. has bonds outstanding with 9 years left to maturity. The bonds have an 8% annual coupon rate and were issued 1 year ago at their par value of $1,000. However, due to changes in interest rates, the bond’s market price has fallen to $901 40. The capital gains yield last year was −9 86%. A. What is the yield to maturity? B. For the coming year, what are...

Question