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Avicorp has a $11.2 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.A) What is Avicorp's pre-tax cost of debt?
B) If Avicorp faces a 40% tax rate, what is its after-tax cost of debt?

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jepessoa

Answer:

A) What is Avicorp's pre-tax cost of debt?

  • 6.73%

B) If Avicorp faces a 40% tax rate, what is its after-tax cost of debt?

  • 4.04%

Explanation:

in order to calculate the pretax cost of debt, I will use a $1,000 bond

coupon rate = 5.8% x $1,000 = $58 / 2 semiannual coupons = $29

current bond price $960

years to maturity = 5 x 2 coupons = 10 periods

you can use a financial calculator or an excel spreadsheet to calculate effective annual yield, but we can also calculate it using the yield tot maturity formula:

YTM = {coupon + [(face value - market value)/n]} / [(face value + market value)/2]

YTM = {29 +  [(1,000 - 960)/10]} / [(1,000 + 960)/2] = 3.367% x 2 coupons per year = 6.73%

the after tax cost of debt = 6.73% x (1 - 40%) = 6.73% x 0.6 = 4.04%

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