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19 September, 07:35

Joliet Company is planning to issue $1,000 par value bonds that have a coupon rate of 9.6%. The bonds will be sold at a market price of $1,120. Flotation costs will amount to 4 percent of market value. The bonds would mature in 15 years and coupon payments would be semi-annual. Joliet's corporate tax rate is 35%. What is the firm's cost of debt financing

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  1. 19 September, 08:03
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    Pre-tax cost of debt is 8.7%

    After-tax cost of debt is 5.66%

    Explanation:

    the cost of debt financing before tax is the yield to maturity on the bond, which can be computed using the rate formula in excel.

    =rate (nper, pmt,-pv, fv)

    nper is the number of times the bonds pay s interest which is 15*2=30

    pmt is the semi-annual interest of the bond:9.6%/2*$1000=$48

    pv is the current market price of $1,120 minus 4% flotation cost i. e 1120*96%=$1075.2

    Fv is the face of the bond at $1000

    =rate (30,48,-1075.2,1000)

    rate=4.35% on semi-annual basis

    rate = 4.35%*2=8.7% on annual basis

    after tax cost of debt = 8.7% * (1-0.35)

    =5.66%
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