A firm has issued $25 million in long-term bonds that now have 9 years remaining until maturity. The bonds carry a 9% annual coupon and are selling in the market for $950.12. The firm also has $35 million in market value of common stock. For cost of capital purposes, what portion of the firm is debt financed and what is the after-tax cost of debt, if the tax rate is 30%? Group of answer choices 71.43% debt financed; 4.92% after-tax cost of debt 59.57% debt financed; 6.30% after-tax cost of debt 40.43% debt financed; 6.89% after-tax cost of debt 41.67% debt financed; 3.45% after-tax cost of debt

40.43% debt financed; 6.89% after-tax cost of debt

Explanation:

In order to determine the portion of the firm financed by debt, we need first of all ascertain the market value of the company

Market value of the firm=market value of equity+market value of debt

market value of equity=$35 million

market value of debt=$25 million*$950.12/$1000=$23.75 million

market value of firm=$ 23.75 million+$35 million = $58.75 million

portion of debt finance=market value of debt/firm's value

=23.75 / 58.75 = 40.43%

The after tax cost = pretax cost of debt * (1-t) where t is the tax rate of 30%

pretax cost of debt is the same yield to maturity computed using rate formula in excel

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

nper is the number of times the bond would pay interest which is nine times

pmt is the annual interest payment=$25 million*9%=$2.25 million

pv is the current price of the bond=$23.75 as shown above

fv is the face value of $25 million

=rate (9,2.25,-23.75,25) = 9.86%

after tax cost of debt=9.86% * (1-0.3) = 6.89%