Question

The Zephyr Corporation is contemplating a new investment to be financed 33 percent from debt. The firm could sell new $1,000 par value bonds at a net price of $945. The coupon interest rate is 16 percent, and the bonds would mature in 14 years. If the company is in a 35 percent tax​ bracket, what is the​ after-tax cost of capital to Zephyr for​ bonds?

Answer 1

Par Value = $ 1000, Net Price = Market Pruce of Bonds = $ 945, Bond Tenure = 14 years and Coupon Rate = 16 % (annual coupon payment and compounding frequency is assumed)

Annual Coupon Payment = 0.16 x 1000 = $ 160

Let the annual Yield to Maturity (YTM) be R

Therefore, 945 = 160 x (1/R) x [1-{1/(1+R)^(14)}] + 1000 / (1+R)^(14)

Using hit and trial method/EXCEL's Goal Seek Function we get:

R = 17.054 %

Tax Rate = 35 %

After-Tax Cost of Debt = (1-Tax Rate) x YTM = (1-0.35) x 17.054 ~ 11.085 %