5.2. Portland Company wants to issue discount bonds with a market value equal to

Question

5.2. Portland Company wants to issue discount bonds with a market value equal to 76% of their face value. The bonds will carry 5% coupon, paying interest semiannually, and they will mature after 10 years. The income tax rate of Portland is 30%.

(A) Calculate the approximate yield-to-maturity of the bonds, and then the after-tax cost of debt for Portland. Answer: (8.409%, 5.886%). Show solutions

(B) Using the concept of original issue discount, write an equation that would give the after-tax cost of debt for Portland. Solve this equation by using WolframAlpha, Maple, or Excel to find the after-tax cost of debt for Portland. Answer: (6.112%) Show solutions

Explanation / Answer

A.FV 100

PV 76

N 20

Coupon 2.5

YTM 8.6% i.e 4.3×2

Post tax cost of debt is 8.6% × (1-0.3) = 6%

B.oid just as a decrease in interest rate will increase the market value.

Due to call protection it has lower tax considerstion

The tax rate will be straight line amortization so will have 8.6% - 2.49% = 6.112%

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