Revive Co. has outstanding 20-year noncallable bonds with a face value of $1000. These bonds have a current market price of $1382.73 and an annual coupon rate of 13%. The comp; any faces a tax rate of 35%.

If the company wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt? A. 6.9%B 5.75%C 5.18%D 6.61%

Question

Nathan

Business

3 November, 11:15

Revive Co. has outstanding 20-year noncallable bonds with a face value of $1000. These bonds have a current market price of $1382.73 and an annual coupon rate of 13%. The comp; any faces a tax rate of 35%.

If the company wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt? A. 6.9%B 5.75%C 5.18%D 6.61%

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Answers (1)

Know the Answer?

Eliezer Lee · Answer 1

5.75%

Explanation:

Firstly, we need to find the yield-to-maturity (YTM) of current outstanding bond as below:

Bond market price = Coupon / (1 + YTM) + Coupon / (1 + YTM) ^2 + Coupon / (1 + YTM) ^3 + ... + Coupon / (1 + YTM) ^20 + Face value / (1 + YTM) ^20, or:

1,382.73 = 130 / (1 + YTM) + 130 / (1 + YTM) ^2 + 130 / (1 + YTM) ^3 + ... + 130 / (1 + YTM) ^20 + 1,000 / (1 + YTM) ^20

Solve the equation, we get YTM = 8.85%.

So, if he company wants to issue new debt, its after-tax cost of debt is 8.85% x (1 - 35%) = 5.75%