Micro Spinoffs Inc. issued 10-year debt a year ago at par value with a coupon ra

Question

Micro Spinoffs Inc. issued 10-year debt a year ago at par value with a coupon rate of 6%, paid annually. Today, the debt is selling at $1,060. If the firm’s tax bracket is 30%, what is its percentage after-tax cost of debt? Assume a face value of $1,000.

Micro Spinoffs Inc. issued 10-year debt a year ago at par value with a coupon rate of 6%, paid annually. Today, the debt is selling at $1,060. If the firm’s tax bracket is 30%, what is its percentage after-tax cost of debt? Assume a face value of $1,000.

Explanation / Answer

Years remainin to maturity = 10 -1 = 9 years

YTM =[interest +(Face value -price)/Years]/[(Face value +price)/2]

      = [60+ (1000 -1060)/9] /[(1000+1060)/2]

    = [60 + (-60/9) ] /[2060/2]

   = [ 60 - 6.67] / 1030

   = 53.33 / 1030

   = .0518 or 5.18%

After tax cost of debt = 5.18 (1 - .30 ) = 5.18* .70 = 3.62%

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