A bond has a $1,000 par value (face value) and a contract or coupon interest rate of 10.1%. The bonds have a current market value of $1,126and will mature in 10 years. The firms marginal tax rate is 34%.
The cost of capital from this bond debt is ____%
To calculate the cost of capital from bond debt, we need to use the yield to maturity (YTM) of the bond.
Here are the steps to calculate the yield to maturity (YTM):
Step 1: Determine the annual coupon payment
The coupon payment is calculated by multiplying the coupon interest rate by the par value of the bond. In this case, the coupon payment would be 10.1% of $1,000, which is $101.
Step 2: Determine the years to maturity
The bond matures in 10 years, so the years to maturity is 10.
Step 3: Determine the current market value
The current market value of the bond is given as $1,126.
Step 4: Calculate the yield to maturity (YTM) using a financial calculator or spreadsheet software. The formula to calculate YTM is a bit complex, so it's easier to use a financial calculator or software.
By inputting the values into a financial calculator or spreadsheet software, we can find that the yield to maturity (YTM) is approximately 7.5%.
Step 5: Calculate the after-tax cost of debt
To find the after-tax cost of debt, we need to consider the firm's marginal tax rate. In this case, the marginal tax rate is given as 34%.
The after-tax cost of debt is calculated by multiplying the YTM by (1 - tax rate). In this case, it would be 7.5% multiplied by (1 - 0.34), which equals approximately 4.95%.
Therefore, the cost of capital from this bond debt is approximately 4.95%.