Question

A firm recently issued $1,000 par value, 20-year bonds with a coupon rate of 6% and semi-annual payments. The bonds sold at par value, but flotation costs amounted to 5% of par value. The firm has a marginal tax rate of 21%. What is the firm's cost of debt for these bonds?
a) 5.09%
b) 6.00%
c) 4.74%
d) 9.48%
e) 6.45%

Answer 1

Answer:

e) 6.45%

Explanation:

Since the coupons are paid semiannually, adjust the coupon payment(PMT), the time (N) of the bond.

You can solve for cost of debt using financial calculator with the following inputs;

Maturity of the bond; N = 20 *2 = 40

Face value; FV = 1000

Coupon payment; PMT = (6%/2) *1000 = 30

Price ; PV = -(1000 - floatation cost) = -(1000 - (5%*1000) = -950

then compute semiannual interest rate; CPT I/Y = 3.224%

Convert semiannual interest rate to annual rate to find the cost of debt;

3.224% *2 = 6.45%