Hi Tech Products has 35,000 bonds outstanding that are currently quoted at 102.3. The bonds mature in 11 years and carry a 9 percent annual coupon. What is the firm's aftertax cost of debt if the applicable tax rate is 35 percent?
To calculate the firm's aftertax cost of debt, we need to use the formula:
Aftertax Cost of Debt = Pre-tax Cost of Debt × (1 - Tax Rate)
1. Start by calculating the pre-tax cost of debt. The pre-tax cost of debt is equal to the coupon rate (9 percent) multiplied by the market price of the bond.
Pre-tax Cost of Debt = Coupon Rate × Market Price
In this case, the coupon rate is 9 percent, and the market price is quoted at 102.3 (which translates to 102.3% of face value). To calculate the market price, divide the quoted price by 100.
Market Price = Quoted Price / 100
Market Price = 102.3 / 100
Market Price = 1.023
Pre-tax Cost of Debt = 0.09 × 1.023
Pre-tax Cost of Debt = 0.09207 (rounded to five decimal places)
2. Now, we can calculate the aftertax cost of debt using the tax rate provided (35%).
Aftertax Cost of Debt = 0.09207 × (1 - 0.35)
Aftertax Cost of Debt = 0.09207 × 0.65
Aftertax Cost of Debt = 0.05984 (rounded to five decimal places)
Therefore, the firm's aftertax cost of debt is approximately 5.984%.