Question

A company's 6% coupon rate, semiannual payment, $1000 par value bond that matures in 30 years sells at a price of $515.16. The company's federal-plus-state tax rate is 40%. What is the firm's after-tax component cost of debt for purposes of valculating the WACC?

Answer 1

Answer:

After-tax cost of debt is 7.2%

Explanation:

Given:

Coupon rate = 6% or 0.06 per annum.

Semi- annual coupon rate = 0.06÷2 = 0.03

Par value is 1,000

Coupon payment = 0.03×1000 = $30

Time period = 30×2= 60 semi-annual periods

Bond price = $515.16

Pre-tax cost of debt can be computed using excel function 'RATE'

=RATE(nper,PMT,PV,FV)

nper is 60; PMT is 30; PV is -515.16 (cash outflow); FV is 1000

Rate is 6%

Calculation is shown in attached excel snip.

Yield to maturity = 6×2 = 12%

Federal tax rate is 40% or 0.4

After-tax cost of debt = 0.12 (1-0.4)

                                  = 0.072 or 7.2%