Porky Pine Co.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.Porky 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 to the company:
Total cost = Bond price - Flotation costs = $1,100 - $50 = $1,050

Next, we need to calculate the annual interest payment:
Annual interest payment = Par value of the bond x Annual coupon rate = $1,000 x 8.5% = $85

We can then calculate the after-tax cost of debt using the following formula:
After-tax cost of debt = (Annual interest payment x (1 - Tax rate)) / (Total cost of the bond)

After-tax cost of debt = ($85 x (1 - 0.35)) / $1,050 = 0.055 or 5.5%

Therefore, the answer is C) 4.70% (rounded to two decimal places).