Question

Electronic Products has 22,500 bonds outstanding that are currently quoted at 101.6. The bonds mature in 8 years and pay an annual coupon payment of $90. What is the firm's aftertax cost of debt if the applicable tax rate is 34 percent?

Answer 1

Answer:

5.75%

Explanation:

to determine the effective cost of the debt, we can use an excel spreadsheet and the IRR function:

• present value = -1,016
• payments 1 - 7 = 90
• payment 8 = 1,090

effective interest rate = 8.71%

we can also calculate the answer using the annuity and present value formula:

1,016 = [90 x ({1 - [1 / (1 + i)⁸]} / i)] + [1,000 / (1 + i)⁸]

but it's much more complicated and the result is the same.

since the effective interest rate = 8.71%, then the after tax rate = 8.71% x (1 - 34%) = 8.71% x 0.66 = 5.7486% ≈ 5.75%