Great Lakes Packing has two bond issues outstanding. The first issue has a coupo

Question

Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of 9 percent, matures in 3 years, has a total face value of $6 million, and is quoted at 108 percent of face value. The second issue has a 7.5 percent coupon, matures in 16 years, has a total face value of $18 million, and is quoted at 97 percent of face value. Both bonds pay interest semiannually. What is the firm's weighted average aftertax cost of debt if the tax rate is 35 percent?

A.

4.78 percent

B.

5.12 percent

C.

5.63 percent

D.

5.95 percent

E.

6.08 percent

A.

4.78 percent

Explanation / Answer

Market Value of first Coupon Bond = 108%*6 = 6.48 Million

Market Value of second Coupon Bond = 18*97% = 17.46 Million

Total market Value = 23.94 Million

First Issue Coupon Bond

Before tax cost of debt = rate(nper,pmt,pv,fv)*2

Nper (indicates the semi annual period) = 3*2 = 6

PV (indicates the current price) = 6.48

PMT (indicate the semi annual payment) = 6*9%*1/2 = 0.27

FV (indicates the face value) = 6

Rate (indicates YTM) = ?

Before tax cost of debt = rate( 6,0.27,-6.48,6)*2

Before tax cost of debt = 6.04 %

Second Issue Coupon Bond

Before tax cost of debt = rate(nper,pmt,pv,fv)*2

Nper (indicates the semi annual period) = 16*2 = 32

PV (indicates the current price) = 17.46

PMT (indicate the semi annual payment) = 18*7.5%*1/2 = 0.675

FV (indicates the face value) = 18

Rate (indicates YTM) = ?

Before tax cost of debt = rate( 32,0.675,-17.46,18)*2

Before tax cost of debt = 7.83 %

weighted average aftertax cost of debt = Weight of First coupon Bond* After tax cost of Debt of First Coupon Bond + Weight of 2nd coupon Bond* After tax cost of Debt of 2nd Coupon Bond

weighted average aftertax cost of debt = 6.48/23.94*6.04*(1-35%) +  17.46/23.94*7.83*(1-35%)

weighted average aftertax cost of debt = 4.78%

Answer

A) 4.78%

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