Tokyo Food Supplies Corporation sold an issue of 12-year bonds. The bonds sold at $980 each. After issuance costs, Tokyo Food Supplies received $975 each. The maturity value is $1,000 each and the coupon rate is 9% and paid annually. What is the after-tax cost of debt for these bonds if Tokyo Food Supplies' marginal tax rate is 40%?

Question

Quizplus · Accepted Answer

The after-tax cost of debt is the yield to maturity multiplied by (1 - tax rate). The yield to maturity is the annual coupon payment plus the change in the bond's price divided by the bond's price. The change in the bond's price is the difference between the maturity value and the purchase price. In this case, the annual coupon payment is $90 (9% * $1,000), the change in the bond's price is $25 ($1,000 - $975), and the purchase price is $975. Therefore, the yield to maturity is (90 + 25) / 975 = 11.83%. The after-tax cost of debt is 11.83% * (1 - 0.40) = 5.61%.

Tokyo Food Supplies Corporation Sold an Issue of 12-Year Bonds