(Cost of deb) Caraway Seed Company issuing a $1,000 par value bond that pays 7 percent annual rest and matures in years Investors are willing to pay 5085 for the bond Flotation costs will be 14 percent of market value. The company is in a 38 percent tax bracket What will be the firm's antenas cost of debt on the bond? The firm's after-tax cost of dietit on the borld was bound to be decimal places)
To calculate the firm's before-tax cost of debt on the bond, we need to take into account the flotation costs. The flotation costs are given as 14% of the market value, which is $5,085. Thus, the flotation costs amount to 0.14 * $5,085 = $710.90.
The net proceeds from the bond issuance will be the market value minus the flotation costs, which is $5,085 - $710.90 = $4,374.10.
Next, we need to calculate the annual interest payment on the bond. The bond pays 7% annual interest on the $1,000 par value, so the annual interest payment is 0.07 * $1,000 = $70.
Since the company is in a 38% tax bracket, the after-tax cost of debt on the bond is the before-tax cost multiplied by (1 - tax rate). Therefore, the after-tax cost of debt on the bond is:
Before-tax cost of debt = annual interest payment / net proceeds from bond issuance
= $70 / $4,374.10 = 0.016
After-tax cost of debt = before-tax cost of debt * (1 - tax rate)
= 0.016 * (1 - 0.38) = 0.016 * 0.62 = 0.00992 or 0.992% (rounded to 4 decimal places)
Therefore, the firm's after-tax cost of debt on the bond is approximately 0.992%.
To calculate the firm's pre-tax cost of debt, we can use the following formula:
Pre-tax Cost of Debt = Annual Interest Payment / Bond Price
First, let's calculate the annual interest payment:
Annual Interest Payment = Par Value x Coupon Rate
= $1,000 x 7% = $70
Next, let's calculate the bond price adjusted for flotation costs:
Bond Price with Flotation Costs = Bond Price / (1 - Flotation Costs)
= $5,085 / (1 - 0.14)
= $5,085 / 0.86
= $5,907.0
Now, we can calculate the pre-tax cost of debt:
Pre-tax Cost of Debt = Annual Interest Payment / Bond Price with Flotation Costs
= $70 / $5,907.0
≈ 0.0118 or 1.18%
To calculate the firm's after-tax cost of debt, we need to incorporate the tax bracket. The after-tax cost of debt can be calculated using the following formula:
After-tax Cost of Debt = Pre-tax Cost of Debt x (1 - Tax Rate)
Let's calculate the after-tax cost of debt:
After-tax Cost of Debt = 1.18% x (1 - 0.38)
≈ 0.0118 x 0.62
≈ 0.007316 or 0.73% (rounded to two decimal places)
Therefore, the firm's after-tax cost of debt on the bond is approximately 0.73%.