Avicorp has a $15.5 million debt issue outstanding, with a 6.3% coupon rate. The debt has semi-annual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 92% of par value. a. What is Avicorp's pre-tax cost of debt? Note: Compute the effective annual return. (Another note: The pre-tax cost of debt is the yield to maturity (YTM) on the outstanding debt issue. We solve for the 6-month YTM on the bond: (This is what I have so far... not sure how they got $920 here:) ** $920 = (31.50/(1+YTM)) + (31.50/(1+YTM)^2)) + (31.50/(1+YTM)^9)) + (31.50 + 1,000)/(1+YTM)^10) Therefore, YTM = 4.1434% Then compute the effective annual return (EAR) as: EAR = (1 + 0.041434)^2 -1 = 0.084585 The pre-tax cost of debt is 4.1434% every 6 months, or 8.4585% per year. b. If Avicorp faces a 40% tax rate, what is its after-tax cost of debt? After-tax cost of debt = EAR x (1-TC) where Tc is Avicorp's tax rate. Then, After- tax cost of debt = 0.084585 x (1-0.4) = 0.050751 If Avicorps faces a 40% tax rate, the after-tax cost of debt is 5.0751%.
Avicorp has a $15.5 million debt issue outstanding, with a 6.3% coupon rate. The debt has semi-annual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 92% of par value. a. What is Avicorp's pre-tax cost of debt? Note: Compute the effective annual return. (Another note: The pre-tax cost of debt is the yield to maturity (YTM) on the outstanding debt issue. We solve for the 6-month YTM on the bond: (This is what I have so far... not sure how they got $920 here:) ** $920 = (31.50/(1+YTM)) + (31.50/(1+YTM)^2)) + (31.50/(1+YTM)^9)) + (31.50 + 1,000)/(1+YTM)^10) Therefore, YTM = 4.1434% Then compute the effective annual return (EAR) as: EAR = (1 + 0.041434)^2 -1 = 0.084585 The pre-tax cost of debt is 4.1434% every 6 months, or 8.4585% per year. b. If Avicorp faces a 40% tax rate, what is its after-tax cost of debt? After-tax cost of debt = EAR x (1-TC) where Tc is Avicorp's tax rate. Then, After- tax cost of debt = 0.084585 x (1-0.4) = 0.050751 If Avicorps faces a 40% tax rate, the after-tax cost of debt is 5.0751%.
Related questions
Ying Import has several bond issues outstanding, each making semiannual interest payments. The bonds are listed in the following table. If the corporate tax rate is 34 percent, what is the aftertax cost of Ying's debt? (Do not round your intermediate calculations.)
NOTE: YTM is given as a decimal, so 0.05 is 5%. Get the market values and then take a market value-weighted average of the YTM. Please note that bond prices are quoted as a percent of par value (or face value). So if you see a price of 98, that means the market value is 98% of the face value. Don't forget to adjust for tax once you have the weighted average YTM, and leave the YTM as an APR.
| Bond | Coupon Rate | Price Quote | Maturity | YTM (quoted as decimal, not %) | Face Value |
| 1 | 6.3% | 108 | 5 years | 0.045 | $ 23,000,000 |
| 2 | 7.4% | 117 | 9 years | 0.0503 | $41,000,000 |
| 3 | 6.4% | 109 | 21 years | 0.0566 | $42,000,000 |
| 4 | 7.7% | 123 | 33 years | 0.0608 | $62,000,000 |
3.5%
5.52%
3.83%
3.46%
3.64%
