Question

Company A's 10 percent coupon rate, quarterly payment, $1,000 par value bond, which matures in 10 years, currently sells at a price of $950. The company's tax rate is 40 percent. Based on the nominal interest rate, what is the firm's component cost of debt for purposes of calculating the WACC

Answer 1

Answer:

Before tax cost of debt = 10.84%

After tax cost of debt = 6.72%

Explanation:

given data

coupon rate = 10%

Maturity value =  $1,000

time = 10 year = 40 Quarter  

currently sells price =  $950

tax rate = 40 percent

solution

we get here first Quarterly Coupon Payment that is

Quarterly Coupon Payment  = 10% × 1,000 ×  $\frac{1}{4}$    

Quarterly Coupon Payment = $25

and

here Cost of Debt is Annual YTM so we get here rate r as Quarterly YTM

so

950 = 25 × PVIFA(r%, 40) + 1,000 × PVFA(r%, 40)  

solve we get

rate r = 2.71 %

so Annual YTM is

Annual YTM = 4 ×  2.71%

Annual YTM =  10.84%

so

Before tax cost of debt = 10.84%

and

After tax cost of debt = 10.84% × (1-0.38)

After tax cost of debt = 6.72%