A bond with a $1,000 par value sells for $895. The coupon rate is 7%, the bonds mature in 20 years, and coupon interest is paid semi-annually. The tax rate is 35%. What is the aftertax cost of this debt?

Question

Business

Kole Kirby

23 November, 17:01

A bond with a $1,000 par value sells for $895. The coupon rate is 7%, the bonds mature in 20 years, and coupon interest is paid semi-annually. The tax rate is 35%. What is the aftertax cost of this debt?

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Jaguar · Answer 1

After tax cost of debt is 5.239%

Explanation:

Given:

Face value = $1,000

Bond price = $895

Coupon payments = 0.035*1,000 = $35 (coupon payment is paid semi-annually so 7% is divided by 2)

Maturity = 20*2 = 40 periods

Using bond price formula:

Bond price = Present value of face value + present value of coupon payments

Use excel function = RATE (nper, pmt, PV, FV) to calculate cost of debt.

substituting the values:

=RATE (40,35,-895,1000)

we get Pre-Tax cost of debt = 4.03% semi - annual

Annual rate is 4.03%*2 = 8.06%

Note: PV is negative as bond price is cash outflow.

After tax cost of debt = 8.06 (1 - 0.35)

= 5.239%