Question

The Cost of Debt and Flotation Costs.

Suppose a company will issue new 25-year debt with a par value of $1,000 and a coupon rate of 9%, paid annually. The issue price will be $1,000. The tax rate is 35%. If the flotation cost is 2% of the issue proceeds, then what is the after-tax cost of debt? Disregard the tax shield from the amortization of flotation costs. Round your answer to two decimal places.
  %

What if the flotation costs were 11% of the bond issue? Round your answer to two decimal places.

Answer 1

Cost of debt

K = N

Bond Price *(1-flotation %) =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =25

980*(1-0.02) =∑ [(9*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^25

k=1

YTM = 9.207038074

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

After tax cost of debt = 9.207038074*(1-0.35)

= 5.99

Cost of debt

K = N

Bond Price *(1-flotation %) =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =25

890*(1-0.11) =∑ [(9*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^25

k=1

YTM = 10.2336862709

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

After tax cost of debt = 10.2336862709*(1-0.35)

= 6.65