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Marina CMI [18]
3 years ago
11

A firm has issued $25 million in long-term bonds that now have 9 years remaining until maturity. The bonds carry a 9% annual cou

pon and are selling in the market for $950.12. The firm also has $35 million in market value of common stock. For cost of capital purposes, what portion of the firm is debt financed and what is the after-tax cost of debt, if the tax rate is 30%? Group of answer choices 71.43% debt financed; 4.92% after-tax cost of debt 59.57% debt financed; 6.30% after-tax cost of debt 40.43% debt financed; 6.89% after-tax cost of debt 41.67% debt financed; 3.45% after-tax cost of debt
Business
1 answer:
tensa zangetsu [6.8K]3 years ago
6 0

Answer:

40.43% debt financed; 6.89% after-tax cost of debt

Explanation:

In order to determine the portion of the firm financed by debt ,we need first of all ascertain the market value of the company

Market value of the firm=market value of equity+market value of debt

market value of equity=$35 million

market value of debt=$25 million*$950.12/$1000=$23.75 million

market value of firm=$ 23.75  million+$35 million= $58.75  million

portion of debt finance=market value of debt/firm's value

                                      =23.75/ 58.75 =40.43%

The after tax cost =pretax cost of debt*(1-t) where t is the tax rate of 30%

pretax cost of debt is the same yield to maturity computed using rate formula in excel

=rate(nper,pmt,-pv,fv)

nper is the number of times the bond would pay interest which is nine times

pmt is the annual interest payment=$25 million*9%=$2.25 million

pv is the current price of the bond=$23.75 as shown above

fv is the face value of $25 million

=rate(9,2.25,-23.75,25)=9.86%

after tax cost of debt=9.86% *(1-0.3)=6.89%

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1. May 15, Assets: Cash         $7,000

Assets: Equipment                $3,000

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4. May 30, Assets: Cash       $1,000

Equity: Service Revenue                          $1,000

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Date          Account Titles        Debit        Credit

1. May 15   Common stock     $7,000

3. May 25, Service revenue    4,000

4. May 30, Service revenue    1,000

Equipment

Date          Account Titles        Debit        Credit

1. May 15   Common stock     $3,000

Office Supplies

Date          Account Titles        Debit        Credit

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Common Stock

Date          Account Titles        Debit        Credit

1. May 15   Cash                                        $7,000

1. May 15   Equipment                                3,000

Accounts Payable

Date          Account Titles        Debit        Credit

2. May 21, Office supplies                         $500

Service Revenue

Date          Account Titles        Debit        Credit

3. May 25, Cash                                       $4,000

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3. May 25, Assets: Cash $4,000 Equity: Service Revenue $4,000

4. May 30, Assets: Cash $1,000 Equity: Service Revenue $1,000

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