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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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  1. 23 November, 19:12
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    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%
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Home » Business » 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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