Avicorp has a $13. 5 million debt issue outstanding, with a 5. 8% coupon rate. T

Question

Avicorp has a $13. 5 million debt issue outstanding, with a 5. 8% coupon rate. The debt has semi-annual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 96% of par value. What is Avicorp's pre-tax cost of debt? Compute the effective annual return. If Avicorp faces a 40% tax rate, what is its after-tax cost of debt? The cost of debt is % per year. (Round to four decimal places.) If Avicorp faces a 40% tax rate, the after-tax cost of debt is %. (Round to four decimal places.)

Explanation / Answer

Here we are using formula of Cost of Debt to find same.

The cost of Debt Rd = [I + ( F - P0 ) / n ] / 0.6P0 + 0.4F

Where P0 = Current Market price of the debeture, I = Annual Interest Payment, n = Number of years, F = Maturity amount,

A. What is Avicorp’s pre-tax cost of debt?

P0 = $12.96 Million, I = 5.8% so semi annually = 2.9%, n=5 so semi annually = 10, F = $13.5 Million

Rd = [ $0.3915 Million + ($13.5 Million - $12.96 Millions) /10 ] / (0.6 * $12.96 million + 0.4 * $13.5 Million)

= [$0.3915 Million + $0.054 Million] / ($7.776 million + $5.4 million) = $0.4455 Million / $13.176 millions = 3.4%

The cost of debt is 3.4% per year.

B. If Avicorp faces a% tax rate, what is its after-tax cost of debt?

Post tax cost of debt = Pre-tax cost of debt ( 1 - Tax rate) = 3.4% ( 1 - 0.4) = 2.04%

If avicorp faces a 40% tax rate, the after tax cost of debt is 2.04%

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