The cost of debt: Beckham Corporation has semiannual bonds outstanding with 13 years to maturity and are currently priced at $746.16. If the bonds have a coupon rate of 8.5 percent, then what is the after-tax cost of debt for Beckham if its marginal tax rate is 35%? Assume that your calculation is made as on Wall Street.

Question

Quizplus · Accepted Answer

To calculate the after-tax cost of debt, we need to first calculate the before-tax cost of debt using the bond price and coupon rate:

Coupon payment = (8.5/2)% x $1000 = $42.50
Number of payments = 13 x 2 = 26
Face value = $1000
Bond price = $746.16

Using a financial calculator, we can find the yield to maturity (YTM) of the bond:
PV = -$746.16 (negative because it represents cash outflow)
PMT = $42.50
FV = $1000
N = 26
Solve for I/Y = YTM/2 = 4.0625%

The before-tax cost of debt is 2 x YTM/2 = 8.125%.

To find the after-tax cost of debt, we need to adjust for the tax savings resulting from the tax-deductibility of interest payments. Since the marginal tax rate is 35%, the after-tax cost of debt is:

After-tax cost of debt = Before-tax cost of debt x (1 - Marginal tax rate)
= 8.125% x (1 - 35%)
= 5.28125%

Rounding to the nearest tenth of a percent, the answer is B) 8.125%.

The Cost of Debt: Beckham Corporation Has Semiannual Bonds Outstanding