Currently, Warren Industries can sell 15-year, $1,000-par-value bonds paying ann

Question

Currently, Warren Industries can sell 15-year, $1,000-par-value bonds paying annual interest at a 11% coupon rate. As a result of current interest rates, the bonds can be sold for $990 each before incurring flotation costs of $25 per bond. The firm is in the 35% tax bracket.

a.Find the net proceeds from the sale of the bond, Nd. (2 demicial places)

b.Calculate the bond's yield to maturity (YTM) to estimate the before-tax and after-tax costs of debt. (2 demicial places)

c.Use the approximation formula to estimate the before-tax and after-tax costs of debt.(2 demicial places)

Explanation / Answer

1Net proceed of bond =proceed from sale-floating charges

                = 990-25=$965

2 YTM= {I+ (F-Po)/n} ÷ {F+Po}/2

Here I = interest

F=face value

Po=current market price

n=no of years

YTM=110+ (1000-965)/15÷ (1000+965)/2

           =112.33333/982.5

             =11.433341815%

             11.433%

YTM before tax=11.433%

3. YTM after tax=11.433 %( 1-35%)

                      =7.432%

YTM can also be calculated by using following equation=

Po= I/ (1+YTM) +F/ (1+YTM)

Here YTM can be find by trial and error method, results from the following formula will be very close to approx

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