11-10.(Cost of debt) Sincere Stationery Corporation needs to raise $500,000 to i
ID: 2441837 • Letter: 1
Question
11-10.(Cost of debt)Sincere Stationery Corporation needs to raise $500,000 to improve its manufacturing plant. It has decided to issue a $1,000 par value bond with a 14 percent annual coupon rate and a 10-year maturity. The investors require a 9 percent rate of return.
a.Compute the market value of the bonds.
b.What will the net price be if flotation costs are 10.5 percent of the market price?
c.How many bonds will the firm have to issue to receive the needed funds?
d.What is the firm’s after-tax cost of debt if its average tax rate is 25 percent and its marginal tax rate is 34 percent?
Explanation / Answer
a.Compute the market value of the bonds.
Price (p0) = 140 x (1-(1+0.09)-10)/0.09 + 1,000 x (1+0.09)-10
= 140 x (1-0.4224)/0.09 + 1,000 x (0.422)
= 140 x 6.418 + 422.00 = $898.52 + $422
= $1,320.52
b.What will the net price be if flotation costs are 10.5 percent of the market price?
NP0 = $1,320.52 x (1 - 0.105) = $1,181.87
c.How many bonds will the firm have to issue to receive the needed funds?
$500,000 / $1,181.87 = 423 Bonds
d.What is the firm’s after-tax cost of debt if its average tax rate is 25 percent and its marginal tax rate is 34 percent?
Cost of debt:
10 $140 $1,000
$1,181.87 = ---------- + -----------
t=1 (1+kd)t (1+kd)10
kd = 10.92%
= 10.92%(1 - 0.34) = 7.21%
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