The cost of debt Gronseth Drywall systems, inc. is in discussions with its inves
ID: 2797052 • Letter: T
Question
The cost of debt Gronseth Drywall systems, inc. is in discussions with its investment bankers regrding the issuance of bonds. The investment banker has informed the firm that different maturities will carry differrent coupon rates and sell different prices. The firm must choose among several alternatives. In each case, the bonds will have a $1000 par value and flotation costs will be $40 per bond. The company is taxed at 35%. Use the approximation formula to calculate the after-tax cost of financing with the following alternative.
The after-tax cost of financing using the approximation formula is? (round to two decimal places)
Coupon rate Time to Maturity Premium or Discount 10% 16 yrs $280Explanation / Answer
The approximate cost formula = C + ((F-P)/n)/((F+P)/2)
where C is the coupon = 10% of 1000 = 100
n = 16
F = Face value = 1000 - 40 = 960
P = Price = 1000 + 280 = 1280
The approximate cost formula = 100+((960-1280)/16) / ((960 +1280)/2) = 80/1120 = 0.071428
After tax cost of financing = 0.071428*(1-0.35) = 0.046428 = 4.64% (Rounded to 2 decimals)
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