Costly Corporation plans a new issue of bonds with a par value of $1000, a maturity of 39 years, and an annual coupon rate of 15.0%. Flotation costs associated with a new debt issue would equal 7.0% of the market value of the bonds. Currently, the appropriate discount rate for bonds of firms similar to Costly is 19.0%. The firm's marginal tax rate is 40%. What will the firm's true cost of debt be for this new bond issue?

Question

Yael

Business

29 January, 20:41

Costly Corporation plans a new issue of bonds with a par value of $1000, a maturity of 39 years, and an annual coupon rate of 15.0%. Flotation costs associated with a new debt issue would equal 7.0% of the market value of the bonds. Currently, the appropriate discount rate for bonds of firms similar to Costly is 19.0%. The firm's marginal tax rate is 40%. What will the firm's true cost of debt be for this new bond issue?

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Paola Hancock · Answer 1

Cost of debt is 15.73%

Explanation:

YTM is the true cost of debt of this bond.

Yield to maturity is the annual rate of return that an investor receives if a bond bond is held until the maturity. it is long term return which is expressed in annual rate.

Face value = $1,000

Coupon Payment = $1,000 x 15% = $150

Proceeds from issuance = $1,000 x (100% - 7%) = $930

Number of payment = n = 39 years

Yield to maturity = [ C + (F - P) / n ] / [ (F + P) / 2 ]

Yield to maturity = [ $150 + ($1,000 - $930) / 39 ] / [ ($1,000 + $930) / 2 ]

Yield to maturity = 15.73%