S.Claus & Co.is planning a zero coupon bond issue that has a par value of $1,000 and matures in 2 years.The bonds will be sold today at a price of $930.00.If the firm's marginal tax rate is 40%,what is the annual after-tax cost of debt to the company on this issue?

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Quizplus · Accepted Answer

The annual before-tax cost of debt is calculated using the formula for the yield to maturity (YTM) on a zero-coupon bond: YTM = [(Face Value / Present Value)^(1/n)] - 1. Here, YTM = [(1000 / 930)^(1/2)] - 1 = 0.0361 or 3.61%. The after-tax cost of debt is YTM * (1 - Tax Rate) = 3.61% * (1 - 0.40) = 2.166%, which rounds to 2.22%.

SClaus & Co