a bond that has a $1000 par value (face value) and a contract or coupon interest rate of 10.9%. The bonds have a current value of $1,120 and will mature in 10 years. The firm's marginal tax rate is 34%. The cost of capital from this bond debt is what percent? round to two decimal places.
To calculate the cost of capital from this bond debt, we need to calculate the yield-to-maturity (YTM) of the bond. Here's how you can do it:
1. Determine the annual interest payment: Multiply the par value of the bond by the coupon interest rate. In this case, the annual interest payment would be $1000 * 10.9% = $109.
2. Determine the periodic interest payment: Divide the annual interest payment by the number of periods per year. Since the bond pays interest annually, the periodic interest payment remains $109.
3. Determine the number of periods: Multiply the number of years to maturity by the number of periods per year. In this case, the number of periods is 10 years * 1 period per year = 10 periods.
4. Determine the present value of the bond at maturity: The bond will mature in 10 years, and its face value is $1000. So, at maturity, the bond will be worth $1000.
5. Calculate the present value of the annual interest payments: We need to discount each interest payment to its present value. To do this, you can use the present value of an ordinary annuity formula.
PV = C * [(1 - (1 + r)^(-n)) / r]
Where PV = present value, C = periodic interest payment, r = periodic interest rate, and n = number of periods.
In this case, PV = $109 * [(1 - (1 + r)^(-10)) / r]
6. Using trial and error or an Excel spreadsheet, find the yield-to-maturity (YTM) that makes the present value of the bond equal to its current value. In this case, the current value of the bond is $1120.
Once you find the YTM, you can calculate the cost of capital, which represents the yield investors expect as a return for holding the bond. Rounded to two decimal places, the cost of capital from this bond debt would be the YTM in percentage terms.
Keep in mind that this method assumes that the bond is held until maturity and that the periodic interest payments received will be reinvested at the same yield.