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? (Always use market value to calculate weight if not otherwise stated)

Explanation / Answer

First Bond Semi annual coupon = 9%*$6 million/2 = 0.27 million Let r be the annual yield Price = 108%*$6 million =6.48 million 6.48 = 0.27/(1+r/2) + 0.27/(1+r/2)^2 +.... 6.27/(1+r/2)^6 r = 3.02*2 = 6.04% Second Bond Semiannual coupon = 7.5%*$6 million/2 = 0.2250 million Let r be the yield Price = 97%*$6 million =5.820 million 5.820 = 0.225/(1+r/2) + 0.225/(1+r/2)^2 + 0.225/(1+r/2)^3......0.225/(1+r/2)^31 + 6.225/(1+r/2)^32 r = 7.83% Cost of debt = weighted average cost of debt of two issue = 7.83%*(5.820 )/(5.820+6.48 ) + 6.04%*6.48/(5.820+6.48 ) =6.89% After tax cost of debt = 6.89%*(1-.35) = 4.8%

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