Bellaire Pharma Ltee. refinances its $2.1 million worth of bonds as they come due at an annual rate of 6%. The current market value of the bonds is $920 for each $1000 bond. If the company's tax rate is 25%, what is the cost of capital of the loan to Bellaire?

Question

Quizplus · Accepted Answer

The cost of debt is calculated as the after-tax yield to maturity. First, find the annual interest payment, which is 6% of $1,000 = $60. Since the bonds are selling for $920, the yield to maturity is $60/$920 = 6.52%. The after-tax cost of debt is then 6.52% * (1 - 0.25) = 4.89%, which rounds to 4.9%.