Question

Joliet Company is planning to issue $1,000 par value bonds that have a coupon rate of 9.6%. The bonds will be sold at a market price of $1,120. Flotation costs will amount to 4 percent of market value. The bonds would mature in 15 years and coupon payments would be semi-annual. Joliet's corporate tax rate is 35%. What is the firm's cost of debt financing

Answer 1

Answer:

Pre-tax cost of debt is 8.7%

After-tax cost of debt is 5.66%

Explanation:

the cost of debt financing  before tax is the yield to maturity on the bond, which can be computed using the rate formula in excel.

=rate(nper,pmt,-pv,fv)

nper  is the number of times the bonds pay s interest which is 15*2=30

pmt is the semi-annual  interest of the bond:9.6%/2*$1000=$48

pv  is the current market price of $1,120 minus 4% flotation cost i.e 1120*96%=$1075.2

Fv is the face of the bond at $1000

=rate(30,48,-1075.2 ,1000)

rate=4.35% on semi-annual basis

rate  =4.35%*2=8.7% on annual basis

after tax cost of debt =8.7%*(1-0.35)

                                    =5.66%