P9-5 (similar to) Question Help * The cost of debt Gronseth Drywall Systems, Inc

Question

P9-5 (similar to) Question Help * 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 40%. Use the approximation formula to calculate the after-tax cost of financing with the following alternative. (Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Coupon rate 7% Time to maturity 17 years Premium or discount - $290 The after-tax cost of financing using the approximation formula is% (Round to two decimal places.) Enter your answer in the answer box and then click Check Answer. All parts showing Clear All Check Answer

Explanation / Answer

Question P9-5). Solution :-

Net proceeds of bond = Face value of bond - Discount on bond issue - Flotation cost.

= 1000 - 290 - 40

= $ 670.

Coupon amount on bond = 1000 * 7 % = $ 70.

Cost of finacing (before-tax) = [ Coupon amount + (Face value of bond - Net proceeds of bond) / Number of Years to maturity ] / (Face value of bond + Net proceeds of bond) / 2

= [ 70 + (1000 - 670) / 17 ] / (1000 + 670) / 2

= [ 70 + 330 / 17 ] / (1670 / 2)

= [ 70 + 19.41 ] / 835

= 89.41 / 835

= 0.1071 i.e., 10.71 % (approx)

Cost of financing (after-tax) = 10.71 % * (1 - 0.40)

= 10.71 % * 0.60

= 6.426 % (Rounded off to 6.43 %)

Conclusion :- Cost of financing (after-tax) = 6.43 % (approx).

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