Nico Trading Corporation is considering issuing long-term debt.The debt would have a 30-year maturity and a 10 percent coupon rate.In order to sell the issue,the bonds must be underpriced at a discount of 5 percent of face value.In addition,the firm would have to pay flotation costs of 5 percent of face value.The firm's tax rate is 21 percent.Given this information,the after-tax cost of debt for Nico Trading would be ________.

Question

Quizplus · Accepted Answer

The after-tax cost of debt is the yield to maturity (YTM) of the bond, which is the annual interest payment divided by the present value of the bond. The present value of the bond is the sum of the present values of the coupon payments and the present value of the face value. The present value of the coupon payments is the sum of the present values of each coupon payment, which is the coupon payment divided by the discount factor. The discount factor is the present value of $1 received at the end of the year, which is 1 / (1 + r)^n, where r is the YTM and n is the number of years until the coupon payment is received. The present value of the face value is the face value divided by the discount factor for the number of years until the face value is received.In this case, the coupon rate is 10%, the maturity is 30 years, the discount rate is 5%, and the flotation costs are 5%. The after-tax cost of debt is:YTM = (Coupon payment + (Face value - Issue price) * YTM * (1 - Tax rate)) / (Issue price)YTM = (0.10 * Face value + (Face value - 0.95 * Face value) * YTM * (1 - 0.21)) / (0.95 * Face value)YTM = (0.10 * Face value + 0.049 * Face value * YTM) / (0.95 * Face value)YTM = 0.1049 / 0.95YTM = 0.1104 or 11.04%Therefore, the after-tax cost of debt for Nico Trading would be 11.04%.

Nico Trading Corporation Is Considering Issuing Long-Term Debt