Airbone Airlines, Inc. has a $1,000 par value bond outstanding with 20 years to

Question

Airbone Airlines, Inc. has a $1,000 par value bond outstanding with 20 years to maturity. The bond carries an annual interest payment of $78 and is currently selling for $875. Airbone is in the 30 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same on the yield to maturity on the old issue because the risk and maturity date will be similar.
a. Compute the approximate yield to maturity (Formula 11-1 on page 333) on the old issue and use this as the yield for the new issue.
b. Make the appropriate tax adjustment to determine the aftertax cost of debt.

Explanation / Answer

a. Let yield to maturity = r 875 = 78/(1+r) + 78/(1+r)^2 + 78/(1+r)^3...................... 1078/(1+r)^20 r= 6.28% b. aftertax cost of debt = 6.28%*(1-30%) =4.40%

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