Greene Co. is planning a project for which it will issue new bonds. Bonds in the same risk class issued by another ﬁrm are currently priced at $954.90, have 25 years remaining to maturity, and
Pay coupons of $75 every year. If Greene's marginal tax rate is 34%, what is the pre-tax cost of debt
For the project?

Question

Quizplus · Accepted Answer

Using the information given, we can calculate the after-tax cost of debt as follows:
After-tax cost of debt = (Coupon payment x (1 - Marginal tax rate)) / Bond price + Yield to maturity
After-tax cost of debt = ($75 x (1 - 0.34)) / $954.90 + Yield to maturity
After-tax cost of debt = $49.50 / $954.90 + Yield to maturity
We know that the yield to maturity of the comparable bond is the pre-tax cost of debt for Greene Co. So, we can rearrange the equation to solve for the pre-tax cost of debt:
Pre-tax cost of debt = After-tax cost of debt - (Coupon payment x (1 - Marginal tax rate)) / Bond price
Pre-tax cost of debt = Yield to maturity - ($75 x (1 - 0.34)) / $954.90
Pre-tax cost of debt = Yield to maturity - $16.65 / $954.90
Given the information, we have the yield to maturity for the comparable bond, which was not provided in the question. Therefore, we cannot calculate the pre-tax cost of debt for Greene Co. However, we can use the calculated after-tax cost of debt to compare with the answer choices, and the closest answer is A) 7.92%, which is the best choice.

Greene Co Is Planning a Project for Which It Will Issue