Question

A corporate bond has a face value of $1,000 and a coupon rate of 6.5%. The bond matures in 10 years and has a current market price of $985. If the corporation sells more bonds it will incur flotation costs of $36 per bond. If the corporate tax rate is 34%, what is the after-tax cost of debt capital?a)5.71%b)5.45%c)5.18%d)4.78%

Answer 1

Answer:After-tax cost of debt capital = 4.78%

Explanation:

Cost of debt (After-tax):

$K_{d}$ = $(\frac{1}{P_{b}} - F)\times$(1 – tax rate)

Where,

$K_{d}$= After tax cost of debt

F = Floatation cost

$P_{b}$ = Net proceeds

Net proceeds = Bond face value ± Premium or Discount

Net proceeds: $ 1000 - $ 15 = $ 985

Flotation cost = $ 36

Tax rate 34% or 0.34

Hence, after tax cost of debt =  $(\frac{65}{985} - 36)\times$(1 - 0.34)

= 4.778 % (approx.)

i.e. 4.78%