Major Manufacturing issued 30-year, 8.5 percent semiannual bonds 6 years ago. The bonds currently sell at 101 percent of face value. What is the firm's aftertax cost of debt if the tax rate is 35 percent?

Question

Quizplus · Accepted Answer

The aftertax cost of debt is the yield to maturity multiplied by (1 - tax rate). The yield to maturity is the annual interest payment plus the change in the bond price divided by the bond price. The annual interest payment is 8.5% * $1,000 = $85. The change in the bond price is (101% - 100%) * $1,000 = $10. The bond price is 101% * $1,000 = $1,010. The yield to maturity is ($85 + $10) / $1,010 = 9.41%. The aftertax cost of debt is 9.41% * (1 - 35%) = 5.46%.

Major Manufacturing Issued 30-Year, 8