Avicorp has a $13.6 million debt issue​ outstanding, with a 6.2 %coupon rate. The debt has​ semi-annual coupons, the next coupon is due in six​ months, and the debt matures in five years. It is currently priced at94 % of par value.a. What is​ Avicorp's pre-tax cost of​ debt? Note: Compute the effective annual return.b. If Avicorp faces a 40% tax​ rate, what is its​ after-tax cost of​ debt?​Note: Assume that the firm will always be able to utilize its full interest tax shield.

Question
Asked Dec 5, 2019
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Avicorp has a $13.6 million debt issue​ outstanding, with a 6.2 %
coupon rate. The debt has​ semi-annual coupons, the next coupon is due in six​ months, and the debt matures in five years. It is currently priced at
94 % of par value.
a. What is​ Avicorp's pre-tax cost of​ debt? Note: Compute the effective annual return.
b. If Avicorp faces a 40% tax​ rate, what is its​ after-tax cost of​ debt?
​Note: Assume that the firm will always be able to utilize its full interest tax shield.
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Expert Answer

Step 1

a.

Computation of the pre-tax cost of debt:

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A B 1 Particulars 2 Outstanding debt issue (million in $) 13.6 6.20% з Coupon rate 4 Coupon due (in months) 5 Debt maturity (in years) 6 Par value 7 Present value (in S) 8 PMT (in $) 9 Number of years (N) 10 Future value (FV- given in S) 5 94% 940 31 10 1000 11 Coupon amount for a period 31 12 Selling price 940 13 Pre-tax cost of the debt for 6 months 3.298% 14 Effective annual return 6.705%

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Step 2

Hence, the pre-tax cost of debt for 6 months is 3.298%, and the effective annual return is 6.705%.

Step 3

Excel calculation:

...
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1 Particulars 2 Outstanding debt issue (million in $) 3 Coupon rate 13.6 0.062 4 Coupon due (in months) 5 Debt maturity (in years) 6 Par value 7 Present value (in $) 8 PMT (in $) 9 Number of years (N) 0.94 =B6*1000 =(1000/2)*B3 =B5*2 10 Future value (FV- given in S) 1000 11 Coupon amount for a period =B10*B3*B4/12 12 Selling price =B10*B6 13 Pre-tax cost of the debt for 6 months =B11/B12 14 Effective annual return |=(1+B13)^2-1

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