Olympic Sports has two issues of debt outstanding. One is a 9% coupon bond with

Question

Olympic Sports has two issues of debt outstanding. One is a 9% coupon bond with a face value of $25 million, a maturity of 10 years, and a yield to maturity of 10%. The coupons are paid annually. The other bond issue has a maturity of 15 years, with coupons also paid annually, and a coupon rate of 10%. The face value of the issue is $30 million, and the issue sells for 93% of par value. The firm's tax rate is 20%.

a. What is the before-tax cost of debt for Olympic? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Before-tax cost of debt %

b. What is Olympic's after-tax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

After-tax cost of debt %

Explanation / Answer

Answer:a. The 9% coupon bond has a yield to maturity of 10% and sells for 93.86% of face value as shown below: Using a financial calculator, enter

n = 10, i = 10%, PMT = 90, FV = 1,000; compute PV = $938.55.

Therefore, the market value of the issue is: 0.9386 × $25 million = $23.465 million

The 10% coupon bond sells for 93% of par value and has a yield to maturity of 10.97%, as shown below:

Using a financial calculator, enter n = 15, PV = ()930, PMT = 100, FV = 1,000; compute i = 10.97%.

The market value of the issue is 0.93 × $30 million = $27.90 million.

Therefore, the weighted-average before-tax cost of debt is:

=10.97%*27.90/51.365+10%( $23.465 /51.365)

=5.958590%+4.568285%

=10.526%

Answer:b after tax cost of debt=(1-0.20)*10.526%

=8.4208%

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