A firm has outstanding debt paying annual coupons,with a coupon rate of 5%,and 10 years to maturity.The firm's bonds are currently trading at a price of $950 per $1000 face value.What is the firm's cost of debt if it has a tax rate of 15%?

Question

Quizplus · Accepted Answer

The first step is to calculate the yield to maturity (YTM) of the bond using the current market price.

$950 = $50/(1+r)^1 + $50/(1+r)^2 + ... + $50/(1+r)^10 + $1000/(1+r)^10

Using a financial calculator or Excel, we can find that the YTM is approximately 5.07%.

Next, we need to adjust for taxes since interest expenses are tax-deductible.

After-tax cost of debt = YTM x (1 - tax rate) 
= 5.07% x (1 - 0.15) 
= 4.31%

Therefore, the firm's cost of debt is approximately 4.31%.

The closest answer choice is C) 4.8%, which is the best choice.

A Firm Has Outstanding Debt Paying Annual Coupons,with a Coupon