Question

Galvatron Metals has a bond outstanding with a coupon rate of 6.5 percent and semiannual payments. The bond currently sells for $1,905 and matures in 15 years. The par value is $2,000 and the company's tax rate is 40 percent. What is the company's aftertax cost of debt?

Answer 1

Information provided:

Par value= future value= $2,000

Coupon rate= 6.5%/2= 3.25%

Coupon payment= 0.0325*2,000= $65

Current price= present value= $1,905

Time= 15 years*2= 30 semi-annual periods

Tax rate= 40%

The question is solved by first computing 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= 2,000

PMT= 65

PV= -1,905

N= 30

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

The value obtained is 3.5085.

Therefore, the yield to maturity is 3.5085*2= 7.02%.

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

                                 = 7.02%*(1- 0.40)

                                 = 4.21%.

                     

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