Question

At the present time, Water and Power Company (WPC) has 5-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,229.24 per bond, carry a coupon rate of 10%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 25%. If WPC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)

Answer 1

Answer:

3.20%

Explanation:

For computing the after tax cost of debt we need to use the RATE formula i.e to be shown in the attachment below:  

Given that,  

Present value = $1,229.24

Future value or Face value = $1,000  

PMT = 1,000 × 10% = $100

NPER = 5 years

The formula is shown below:  

= Rate(NPER;PMT;-PV;FV;type)  

The present value come in negative  

So, after applying the above formula

1. The pretax cost of debt is 4.74%

2. And, the after tax cost of debt would be

= Pretax cost of debt × ( 1 - tax rate)

= 4.74% % × ( 1 - 0.25)

= 3.20%