Dou's Oriental Hotels, Incorporated sold an issue of 10-year bonds. The bonds sold at $995 each. After issuance costs, Dou's Oriental Hotels received $985 each. The maturity value is $1,000 each and the coupon rate is 7 5/8% and paid annually. What is the after-tax cost of debt for these bonds if Dou's Oriental Hotels' marginal tax rate is 40%?

Question

Quizplus · Accepted Answer

The after-tax cost of debt can be calculated using the formula: After-tax cost of debt = (Annual interest payment - Tax savings on interest) / Net proceeds from the bond sale + (Maturity value - Net proceeds from the bond sale) / Number of years to maturity) / ((Maturity value + Net proceeds from the bond sale) / 2). The annual interest payment is $76.25 ($1,000 * 7.625%), tax savings on interest is $30.50 ($76.25 * 40%), net proceeds from the bond sale are $985, and the number of years to maturity is 10. Plugging these values into the formula gives an after-tax cost of debt of approximately 4.71%.

Dou's Oriental Hotels, Incorporated Sold an Issue of 10-Year Bonds