Question

Suppose a company will issue new 20-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 25%. If the flotation cost is 2% of the issue proceeds, then what is the after-tax cost of debt

Answer 1

Answer:

After cost of debt for a floatation cost of 2% is 6.62%

Explanation:

After tax cost of debt = Market interest × (1- tax rate)

We will get the cost of debt using the time value of money principle.

PV = -$1,000

Pmt = $1,000 × 9%

=$90

P/yr = 1

N = 20

FV =1,000

Tax rate = 25%

YTM

The market interest rate is 9% using financial calculator hence;

After-tax cost of debt = Market interest × (1-tax rate)

= 0.09 × (1 - 0.25)

= 0.0675 or 6.75%

If floatation cost is 2%, then

Net receipts after floatation cost = Cost × (1 - floatation rate)

= 0.0675 × (1- 0.02)

= 0.06615 or 6.62%