Question

Galvatron Metals has a bond outstanding with a coupon rate of 6.6 percent and semiannual payments. The bond currently sells for $1,856 and matures in 22 years. The par value is $2,000 and the company's tax rate is 39 percent. What is the company's aftertax cost of debt?

Answer 1

Information provided:

Par value= future value= $2,000

Current price= present value= $1,856

Time= 22 years*2= 44 semi-annual periods

Coupon rate= 6.6%/2= 3.3%

Coupon payment= 0.033*2,000= $66

Tax rate= 39%

The question is solved by first calculating the before tax cost of debt.

The yield to maturity is computed to derive the before tax cost of debt.

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

FV= 2,000

PV= -1,856

N= 44

PMT= 66

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

The value obtained is 3.6301.

Therefore, the before tax cost of debt is 3.6301*2=7.2602%

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

                                        = 7.2602% *(1- 0.39)

                                        = 4.4287%   4.43%.

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