Fashion Wear has bonds outstanding that mature in 12 years, pay interest annually, and have a coupon rate of 7.5 percent. These bonds have a face value of $1,000 and a current market price of $1,060. What is the company's aftertax cost of debt if its tax rate is 35 percent?

4.39%

Explanation:

Given:

Face value of bond (FV) = $1,000

Coupon rate = 7.5%

Coupon payment (PMT) = 0.075 * 1,000 = $75

Present value of bond (PV) = $1,060

Maturity = 12 years

Compute yield or rate using spreadsheet = Rate (nper, pmt,-PV, FV)

Substituting the values we get,

=RATE (12,75,-1060,1000)

Rate or yield is computed as 6.75%

Present value is negative as it is a cash outflow.

Cost of debt is 6.75%

Tax rate is 35%

After tax cost of debt = 6.75% * (1 - 0.35)

= 4.39%