Avicorp has a $ 12.9 million debt issue outstanding, with a 5.9 % coupon rate. The debt has semi-annual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 93 % of par value. a. What is Avicorp's pre-tax cost of debt? Note: Compute the effective annual return. b. If Avicorp faces a 40 % tax rate, what is its after-tax cost of debt? Note: Assume that the firm will always be able to utilize its full interest tax shield.

Question

Rylee Wilkerson

Business

3 April, 19:52

Avicorp has a $ 12.9 million debt issue outstanding, with a 5.9 % coupon rate. The debt has semi-annual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 93 % of par value. a. What is Avicorp's pre-tax cost of debt? Note: Compute the effective annual return. b. If Avicorp faces a 40 % tax rate, what is its after-tax cost of debt? Note: Assume that the firm will always be able to utilize its full interest tax shield.

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Riley Clarke · Answer 1

a)

Pre-tax Cost Of Debt = 7.64%

b)

Tax Rate = 40%

Post Tax cost of debt = 7.33% * (1 - 40%) = 4.58%

So Post Tax cost of Debt = 4.58%

Explanation:

Bond Par Value = 12,900,000

Bond Market Price 93% of face value = 11,997,000

Years To maturity = 5.00

Annual Interest 5.9% = 761,100

Formula = [Annual Interest + (Par Value-Market Value) / Years to Maturity] / [ (Par value+Market Price*2) / 3]

Year To Maturity = [761100 + (12900000 - 11997000) / 5] / (12900000 + 2*11997000) / 3

Year to maturity = 7.33%