a bond that has a 1000 par value (face value and a contract or coupon interest rate of 10.9%. the bond have a current market value of $1,120 and will mature in 10 years. the firm's marginal tax rate is 34%. the cost of captial from this debit is
To calculate the cost of debt for the given bond, you will need to consider the following components:
1. Coupon Payment: This is the annual interest payment made by the bond issuer to bondholders. In this case, the coupon interest rate is 10.9% of the par value ($1000), so the annual coupon payment is ($1000 * 10.9%) = $109.
2. Market Value: This is the current market price at which the bond is being traded. In this case, the bond's market value is given as $1,120.
3. Maturity: This refers to the period until the bond reaches its maturity date. In this case, the bond will mature in 10 years.
4. Marginal Tax Rate: This represents the tax rate applicable to the interest income generated from the bond. In this case, the marginal tax rate is stated as 34%.
To calculate the cost of debt using the bond's characteristics, we can use the yield to maturity (YTM) approach. YTM is the total return anticipated on a bond if it is held until it matures.
The formula to calculate YTM is as follows:
Market Value = (Coupon Payment / (1 + YTM)^1) + (Coupon Payment / (1 + YTM)^2) + ... + (Coupon Payment + Par Value) / (1 + YTM)^n
Where:
- YTM is the yield to maturity
- n is the number of periods until maturity
Using this formula, we need to solve for YTM. However, this calculation involves an iterative process and requires the use of financial calculators or spreadsheet software. An approximate estimation can be obtained through trial and error.
Alternatively, you can use financial calculators or online tools with built-in YTM calculators to find the approximate yield to maturity based on the given bond characteristics (par value, coupon rate, market value, and maturity).
Once you find the yield to maturity (YTM), the cost of debt from this bond can be considered as the after-tax yield, which will be the YTM multiplied by (1 - tax rate).
Please note that this explanation provides you with the steps to calculate the cost of debt. You may need to seek professional financial advice or use specialized financial software for accurate results.