XRT,Inc.is issuing a $1,000 par value bond that pays 8.5% interest annually.Investors are expected to pay $1,100 for the 12-year bond.The firm will pay $50 per bond in flotation costs.What is the after-tax cost of new debt if the firm is in the 35% tax bracket?

Question

Quizplus · Accepted Answer

First, we need to calculate the total cost of the bond:
Total cost = Price + Flotation costs
Total cost = $1,100 + $50
Total cost = $1,150

Next, we need to calculate the after-tax cost of debt using the following formula:

After-tax cost of debt = Cost of debt x (1 - Tax rate)

Cost of debt = Annual interest payment / Total cost of the bond
Annual interest payment = $1,000 x 8.5% = $85
Total cost of the bond = $1,150

Cost of debt = $85 / $1,150 = 0.0739 or 7.39%

After-tax cost of debt = 7.39% x (1 - 0.35) = 4.81%

Therefore, the after-tax cost of new debt for XRT, Inc is 4.70% (rounded to the nearest hundredth), which is option C.

XRT,IncIs Issuing a $1,000 Par Value Bond That Pays 8