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23 January, 15:50

Fashion Wear has bonds outstanding that mature in 12 years, pay interest annually, and have a coupon rate of 7.5 percent. These bonds have a face value of $1,000 and a current market price of $1,060. What is the company's aftertax cost of debt if its tax rate is 35 percent?

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  1. 23 January, 16:17
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    4.39%

    Explanation:

    Given:

    Face value of bond (FV) = $1,000

    Coupon rate = 7.5%

    Coupon payment (PMT) = 0.075 * 1,000 = $75

    Present value of bond (PV) = $1,060

    Maturity = 12 years

    Compute yield or rate using spreadsheet = Rate (nper, pmt,-PV, FV)

    Substituting the values we get,

    =RATE (12,75,-1060,1000)

    Rate or yield is computed as 6.75%

    Present value is negative as it is a cash outflow.

    Cost of debt is 6.75%

    Tax rate is 35%

    After tax cost of debt = 6.75% * (1 - 0.35)

    = 4.39%
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