You are analyzing the after-tax cost of debt for a firm. You know that the firm’
ID: 2765785 • Letter: Y
Question
You are analyzing the after-tax cost of debt for a firm. You know that the firm’s 12-year maturity, 10.25 percent semiannual coupon bonds are selling at a price of $898.31. If these bonds are the only debt outstanding for the firm.
YTM is 11.86
What is the after-tax cost of debt for this firm if it has a marginal tax rate of 34 percent? 7.83
What is the current YTM of the bonds and after-tax cost of debt for this firm if the bonds are selling at par? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answers to 2 decimal places, e.g. 15.25%.)
SOLVE THE YTM AND AFTER TAX COST OF DEBT
Explanation / Answer
Answer:
1) After tax cost of debt = Yield to Maturity or YTM x (1 - Tax Rate) = 11.86% x (1 - 0.34) = 7.8276%
Why we have taken Yield to Maturity to calculate After tax cost of debt?
YTM is the available rate of return from bond if it is purchased and hold till maturity period. YTM is such discount rate at which PV of future inflow of bond will equal to the amount invested in such bond (i.e. PV of Outflow)
2) What is Current YTM if bonds are selling at par = If bonds are selling at par the YTM is the coupon rate = 10.25%
Hence, After tax cost of debt = YTM x (1 - Tax Rate) = 10.25% x (1 - 0.34) = 6.765%
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