The cost of debt Gronseth Drywall Systems, Inc., is in discussions with its inve

Question

The cost of debt Gronseth Drywall Systems, Inc., is in discussions with its investment bankers regarding the issuance of new bonds. The investment banker has informed the firm that different maturities will carry different coupon rates and sell at different prices. The firm must choose among several alternatives. In each case, the bonds will have a $1,000 par value and flotation costs will be $40 per bond. The company is taxed at 35%. Use the approximation formula to calculate the after-tax cost of financing with the following alternative coupon rate 9% Time to maturity 12 years Premium or discount - $250 The after-tax cost of financing using the approximation formula is % (Round to two decimal places.

Explanation / Answer

price = 1000 -250 = 750

before cost of debt = [coupon payment + (face value-price/number of years to maturity)]/(price+facevalue)/2

= [90 + (1000-750)/12]/(1000+750)/2

= 12.6667%

after tax cost of debt = before tax cost of debt * (1- tax rate)

= 12.6667% * (1-35%)

= 8.23%

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