Question

Mom's Apple Pies has an 8 percent semiannual coupon bond issue outstanding that is selling for 102 percent of par and which matures in 20 years. If Mom's faces an average tax rate of 27%, what will be the after-tax cost of debt?

Answer 1

Information provided:

Par value= future value= $1,000

Coupon rate= 8%/2= 4%

Coupon payment= 0.04*1,000= $40

Current price= present value= 102%*1,000= $1,020

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

Tax rate= 27%

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= 1,000

PMT= 40

PV= -1,020

N= 40

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

The value obtained is 3.9.

Therefore, the yield to maturity is 3.9*2= 7.80%.

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

                                 = 7.80%*(1- 0.27)

= 5.69%.

                     

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