The cost of debt: PackMan Corporation has semiannual bonds outstanding with nine years to maturity and are currently priced at $754.08. If the bonds have a coupon rate of 7.25 percent, then what is the after-tax cost of debt for Beckham if its marginal tax rate is 30 percent? Complete the calculation as is done on Wall Street.

Question

Quizplus · Accepted Answer

The after-tax cost of debt is the yield to maturity (YTM) of the bond multiplied by (1 - the marginal tax rate). The YTM is the annual interest payment divided by the bond price plus the annual change in the bond price. The annual interest payment is the coupon rate multiplied by the face value of the bond. The annual change in the bond price is the difference between the bond price and the face value of the bond divided by the number of years to maturity.In this case, the coupon rate is 7.25%, the bond price is $754.08, the face value of the bond is $1,000, and the number of years to maturity is nine. The annual interest payment is $72.50. The annual change in the bond price is ($1,000 - $754.08) / 9 = $27.42. The YTM is ($72.50 + $27.42) / $754.08 = 13.25%. The after-tax cost of debt is 13.25% * (1 - 0.30) = 9.275%.

The Cost of Debt: PackMan Corporation Has Semiannual Bonds Outstanding