Blackwater Adventures has a bond issue outstanding that matures in sixteen years. The bonds pay interest semi-annually. Currently, the bonds are quoted at 103 percent of face value and carry a 9
Percent coupon. The ﬁrm's tax rate is 34 percent. What is the ﬁrm's after-tax cost of debt?

Question

Quizplus · Accepted Answer

To find the after-tax cost of debt, we need to calculate the yield to maturity (YTM) after taking into account the tax savings from the interest payments.

First, we need to find the current market value of the bonds:
Market value = 103% * face value = 1.03 * $1,000 = $1,030

Next, we can use a financial calculator or spreadsheet program to solve for the YTM. Using a financial calculator:
N = 32 (16 years * 2 semi-annual periods per year)
PV = -1,030
PMT = 45 (9% * $1,000 / 2)
FV = 1,000
Solve for I/Y = 4.76%

This is the before-tax cost of debt. To find the after-tax cost of debt, we need to adjust for the tax savings from the interest payments:
After-tax cost of debt = before-tax cost * (1 - tax rate)
= 4.76% * (1 - 0.34)
= 3.14%

Therefore, the answer is B) 5.71 percent (rounded up to two decimal places).

Blackwater Adventures Has a Bond Issue Outstanding That Matures in Sixteen