Question

A firm recently issued $1,000 par value, 20-year bonds with a coupon rate of 9%. Coupon interest payments will be paid semi-annually. The bonds sold at par value, but the firm paid flotation costs amounting to 5% of par value. The firm has a tax rate of 21%. What is the firm's after-tax cost of debt for these bonds?

Answer 1

Answer:

cost of debt 0.0748421 = 7.48%

Explanation:

$\frac{r(1-t)}{(1-f)} = after tax cost of debt$

The flotation cost makes the cost increase as we did not receive the whole amount but a diminished portion.

Also, the cost is decrease as are tax deductible making the interest expense to provide a tax shield.

pretax cost of debt =

0.09 x (1 -0.21) / (1 - 0.05) = 0,0748421