Question

Boulder Furniture has bonds outstanding that mature in 15 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,075. What is the company's aftertax cost of debt if its tax rate is 32 percent?

Answer 1

Answer:

The company's after-tax cost of debt is  

Explanation:

Please find the below for detailed calculation and explanations:

The company's after-tax cost of debt is equal to: Bond's yield to maturity (YTM) x ( 1- tax rate). As tax rate is given, we need to calculate the YTM.

Bond's YTM is the discount rate which brings net present value of all cash flows from the bond, which are 15 annual interest payments of $60 each ( $1,000 x 6%) and face value repayment of $1,000 at maturity, equal to its current market price of $1,075. So, it is calculated as below:

( 60/ YTM) x [ 1 - (1+YTM)^-15 ] + 1,000/ (1+YTM)^15 = 1,075 <=> YTM = 5.26%.

=> The company's after-tax cost of debt is equal to: Bond's YTM x ( 1- tax rate) = 5.26% x ( 1 - 32%) = 3.58%.