Question

At the present time, Perpetualcold Refrigeration Company (PRC) has 10-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,278.41 per bond, carry a coupon rate of 11%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 25%. If PRC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)

Answer 1

Answer:

after-tax cost of debt 5.2725%

Explanation:

We will solve for the market rate of the bonds which is the one that makes the maturity and coupon payment equal to its current market price:

We sovle it using a financial calcualtor or excel goal seek tool

$C \times \frac{1-(1+r)^{-time} }{rate} = PV$

C 110.000 (1,000 x 11%)

time  10 years

rate 0.070304812

$110 \times \frac{1-(1+0.0703048118151927)^{-10} }{0.0703048118151927} = PV$

PV $771.5066

$\frac{Maturity}{(1 + rate)^{time} } = PV$  

Maturity   1,000

time   10 years  

rate  0.070304812

$\frac{1000}{(1 + 0.0703048118151927)^{10} } = PV$  

PV   506.90

PV c $771.5066

PV m  $506.9034

Total $1,278.4100

Now that we find that market rate is 7.03%

we calcautle the after tax cost of debt:

7.03 x (1 - 25%) = 5.2725%