Question

In: Finance

Contrail Air, Inc is trying to determine its cost of debt. The company has an outstanding...

Contrail Air, Inc is trying to determine its cost of debt. The company has an outstanding debt issue with 18 years to maturity that is quoted at 95.00% percent of face value. The issue makes semiannual payments and has a coupon rate of 8.00% percent. What is the after tax cost of debt?

Settlement 01/01/2000
Maturity 01/01/2018
Price (% of par) 95  
Coupon rate 8%
Payments per year 2  
Tax rate 35%
Pretax cost 8.55%

5.56%

11.54%

6.33%

13.15%

Solutions

Expert Solution

Information provided:

Face value= future value= $1,000

Time= 18 years*2= 36 semi-annual periods

Present value= 95%*1,000= $950

Coupon rate= 8%/2= 4%

Coupon payment= 0.04*1,000= $40

The question is solved by first calculating the before tax cost of debt which is the yield to maturity.

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

FV= $1,000

N= 36

PMT= 40

PV= -950

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

The value obtained is 4.2746.

                                   

Hence, the yield to maturity is 4.2746%*2= 8.55%.

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

                                 = 8.55%*(1- 0.35)

                                 = 5.56%.

Hence, the answer is option a.        

In case of any query, kindly comment on the solution.

                             


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