Joliet Company is planning to issue $1,000 par value bonds that have a coupon rate of 9.6%. The bonds will be sold at a market price of $1,120. Flotation costs will amount to 4 percent of market value. The bonds would mature in 15 years and coupon payments would be semi-annual. Joliet's corporate tax rate is 35%. What is the firm's cost of debt financing

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Business

Schotzie

10 November, 13:22

Joliet Company is planning to issue $1,000 par value bonds that have a coupon rate of 9.6%. The bonds will be sold at a market price of $1,120. Flotation costs will amount to 4 percent of market value. The bonds would mature in 15 years and coupon payments would be semi-annual. Joliet's corporate tax rate is 35%. What is the firm's cost of debt financing

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Abdullah Duffy · Answer 1

Pre-tax cost of debt is 8.7%

After-tax cost of debt is 5.66%

Explanation:

the cost of debt financing before tax is the yield to maturity on the bond, which can be computed using the rate formula in excel.

=rate (nper, pmt,-pv, fv)

nper is the number of times the bonds pay s interest which is 15*2=30

pmt is the semi-annual interest of the bond:9.6%/2*$1000=$48

pv is the current market price of $1,120 minus 4% flotation cost i. e 1120*96%=$1075.2

Fv is the face of the bond at $1000

=rate (30,48,-1075.2,1000)

rate=4.35% on semi-annual basis

rate = 4.35%*2=8.7% on annual basis

after tax cost of debt = 8.7% * (1-0.35)

=5.66%