LeeBurly Corporation ’s financial manager , Mr. George Peltay, has collected the
ID: 2668061 • Letter: L
Question
LeeBurly Corporation ’s financial manager , Mr. George Peltay, has collected the following information to calculate its WACC:
• LeeBurly’s capital structure consists of 40% debt and 60% common stock.
• LeeBurly has 25-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,252.
• LeeBurly uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 5% and the market risk premium is 6%. LeeBurly’s common stock has a beta of 1.6. LeeBurly’s tax rate is 40%.(7 points)
What is the company’s after-tax cost of debt?
Explanation / Answer
According to the given information, Face value of the bonds = $1000 Current price of the bonds = $1252 Annual coupon rate = 12% Years to maturity = 25 Annual coupon payment = Face value * Coupon rate = $1000 * 12% = $120 Computing the Cost of debt using excel sheet: Step1: Go to excel and click "Insert" to insert the function. Step2: Select the "Rate" function as we are finding the yield of the bond at the time of maturity. Step3: Enter the values as Nper = 25; PMT = -120; PV = 1252; FV = -1000 Step4: Click "OK" to get the desired value. The value comes to " 9.36%" Therefore, the cost of debt is 9.36% Note: The payment is shown in negative because it is a cash outflow for the Company The future value is always shown in negative sign because it is an amount that will be received in the future. Calculating the After-tax cost of debt: After-tax cost of debt = Before-tax cost of debt (1 - Tax rate) = 0.0936 (1 - 0.40) = 0.0936 (0.60) = 0.05616 or 5.62% Therefore, the after-tax cost of debt is 5.62%Related Questions
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