company issuing $1,000 par value bond that pays 7% annual interest maturing in 15 yrs. Investors willing to pay $958 for bond. Flotation cost 11% of market value and tax rate 18%. What will be theafter-tax cost of debt?
To calculate the after-tax cost of debt, we need to consider the factors given: the annual interest rate, the flotation cost, and the tax rate. Here's how you can calculate it step by step:
Step 1: Calculate the annual interest payment
The annual interest payment can be calculated by multiplying the par value of the bond ($1,000) by the annual interest rate (7% or 0.07):
Interest payment = $1,000 * 0.07 = $70
Step 2: Calculate the flotation cost
The flotation cost is given as 11% of the market value of the bond. Since investors are willing to pay $958 for the bond, we can calculate the flotation cost by multiplying $958 by 0.11:
Flotation cost = $958 * 0.11 = $105.38
Step 3: Calculate the after-tax flotation cost
To calculate the after-tax flotation cost, we need to consider the tax rate. Multiply the flotation cost by (1 - tax rate):
After-tax flotation cost = $105.38 * (1 - 0.18) = $86.42
Step 4: Calculate the after-tax cost of debt
Finally, to calculate the after-tax cost of debt, we need to consider both the interest payment and the after-tax flotation cost. Add the interest payment and after-tax flotation cost, then divide it by the market value of the bond:
After-tax cost of debt = ($70 + $86.42) / $958 ≈ 0.1592 or 15.92%
Therefore, the after-tax cost of debt is approximately 15.92%.