Bond with $1000 par value and a contract interest rate of 10.8%. Bonds current market rate is $1123 and matures in 10 years. Marginal tax rate is 34%. What is the cost of capital from this bond debt?
To calculate the cost of capital from this bond debt, we'll need to consider the characteristics of the bond and the impact of taxes. Here's how to calculate it step-by-step:
1. Calculate the annual interest payment: The annual interest payment is determined by multiplying the par value ($1000) by the contract interest rate (10.8%). In this case, it is $1000 * 10.8% = $108.
2. Calculate the current market value of the bond: The current market value of the bond is $1123.
3. Calculate the annual interest yield: The annual interest yield is determined by dividing the annual interest payment ($108) by the current market value of the bond ($1123) and multiplying by 100 to convert it to a percentage. In this case, it is ($108 / $1123) * 100 = 9.62%.
4. Calculate the after-tax cost of debt: The after-tax cost of debt accounts for the effect of taxes. To calculate it, multiply the annual interest yield (9.62%) by 1 minus the marginal tax rate (34%). In this case, it is 9.62% * (1 - 34%) = 6.35%.
Therefore, the cost of capital from this bond debt is approximately 6.35%.