Olympic Sports has two issues of debt outstanding. One is a 5% coupon bond with
ID: 2819929 • Letter: O
Question
Olympic Sports has two issues of debt outstanding. One is a 5% coupon bond with a face value of $33 million, a maturity of 10 years, and a yield to maturity of 6%. 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 6%. The face value of the issue is $38 million, and the issue sells for 90% of par value. The firm's tax rate is 30%.
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.)
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.)
Explanation / Answer
a)
Bond 1:
Face value = $33,000,000
Coupon payment = 0.05 * 33,000,000 = 1,650,000
Price of bond = Coupon * [ 1 - 1 / ( 1 + r)n] / r + Fv / ( 1 + r)n
Price of bond = 1,650,000 * [ 1 - 1 / ( 1 + 0.06)10] / 0.06 + 33,000,000 / ( 1 + 0.06)10
Price of bond = 1,650,000 * 7.360087 + 18,427,027.64
Price of bond = $30,571,171.196
Bond 2:
Price = 0.9 * 38,000,000 = 34,200,000
Coupon = 0.06 * 38,000,000 = 2,280,000
Before tax cost of debt of bond using a financial calculator = 7.1053%
Keys to use in a financial calculator: PV -34,200,000, FV 38,000,000, N 15, PMT 2,280,000, CPT I/Y
Total market value = 34,200,000 + 30,571,171.196 = 64,771,171.19
Before tax cost of debt for olympic = (30,571,171.196 / 64,771,171.19)* 0.06 + ( 34,200,000 / 64,771,171.19) * 0.071053
Before tax cost of debt for olympic = 0.028319 + 0.037517
Before tax cost of debt for olympic = 0.0658 or 6.58%
b)
After tax cost of debt = 0.0658 ( 1 - 0.3)
After tax cost of debt = 0.0461 or 4.61%
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