Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
expand_more
expand_more
format_list_bulleted
Related questions
Question
![### Understanding Cost of Debt Calculation
**ICU Window, Inc.** is trying to determine its cost of debt. The firm has a debt issue outstanding with 8 years to maturity that is quoted at 106.5 percent of face value. The issue makes semiannual payments and has an embedded cost of 6.4 percent annually. The question posits:
**What is ICU's pretax cost of debt?**
And if the tax rate is 23 percent, **what is the after-tax cost of debt?**
#### Detailed Breakdown:
1. **Debt Issue Details:**
- **Time to Maturity:** 8 years
- **Quoted Price:** 106.5% of face value
- **Payment Frequency:** Semiannual
- **Annual Embedded Cost:** 6.4%
2. **Calculating Pretax Cost of Debt:**
- Convert the annual cost to a semiannual rate (since payments are semiannual):
\[
\text{Semiannual interest rate} = \frac{6.4\%}{2} = 3.2\%
\]
- Determining the actual price paid versus the face value gives us:
\[
\text{Price} = 106.5\% = 1.065 \text{ (as a decimal)}
\]
- With an 8-year term and semiannual payments, you have 2 * 8 = 16 periods.
3. **After-Tax Cost of Debt Calculation:**
- Given a tax rate of 23%, the after-tax cost of debt can be calculated as follows:
\[
\text{After-tax cost of debt} = \text{Pretax cost of debt} \times (1 - \text{Tax Rate})
\]
So, to determine the after-tax cost, you multiply the pretax cost by (1 - 0.23).
#### Application in Financial Planning:
Understanding these calculations is crucial for financial planning and corporate finance management, particularly in making decisions about financing through debt versus other means. The cost of debt impacts the overall cost of capital, influencing project evaluations and long-term financial strategies.
Use this breakdown to solve similar problems by following the given steps: identifying the components of the debt issue, calculating pretax costs, and adjusting for tax impacts.](https://content.bartleby.com/qna-images/question/ce618159-930e-4ade-8eed-109751c2dc39/60cf178e-e35c-41bf-9bc2-d6bc32f94992/7p8gil.png)
Transcribed Image Text:### Understanding Cost of Debt Calculation
**ICU Window, Inc.** is trying to determine its cost of debt. The firm has a debt issue outstanding with 8 years to maturity that is quoted at 106.5 percent of face value. The issue makes semiannual payments and has an embedded cost of 6.4 percent annually. The question posits:
**What is ICU's pretax cost of debt?**
And if the tax rate is 23 percent, **what is the after-tax cost of debt?**
#### Detailed Breakdown:
1. **Debt Issue Details:**
- **Time to Maturity:** 8 years
- **Quoted Price:** 106.5% of face value
- **Payment Frequency:** Semiannual
- **Annual Embedded Cost:** 6.4%
2. **Calculating Pretax Cost of Debt:**
- Convert the annual cost to a semiannual rate (since payments are semiannual):
\[
\text{Semiannual interest rate} = \frac{6.4\%}{2} = 3.2\%
\]
- Determining the actual price paid versus the face value gives us:
\[
\text{Price} = 106.5\% = 1.065 \text{ (as a decimal)}
\]
- With an 8-year term and semiannual payments, you have 2 * 8 = 16 periods.
3. **After-Tax Cost of Debt Calculation:**
- Given a tax rate of 23%, the after-tax cost of debt can be calculated as follows:
\[
\text{After-tax cost of debt} = \text{Pretax cost of debt} \times (1 - \text{Tax Rate})
\]
So, to determine the after-tax cost, you multiply the pretax cost by (1 - 0.23).
#### Application in Financial Planning:
Understanding these calculations is crucial for financial planning and corporate finance management, particularly in making decisions about financing through debt versus other means. The cost of debt impacts the overall cost of capital, influencing project evaluations and long-term financial strategies.
Use this breakdown to solve similar problems by following the given steps: identifying the components of the debt issue, calculating pretax costs, and adjusting for tax impacts.
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution
Trending nowThis is a popular solution!
Step by stepSolved in 2 steps with 2 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with seven years to maturity that is quoted at 114 percent of face value. The issue makes semiannual payments and has an embedded cost of 9.8 percent annually.arrow_forwardBBA Ltd has just issued $10 million in debt (at par or face value). The firm will pay interest only on this debt. BBA’s marginal tax rate is expected to be 30% for the foreseeable future. a) Suppose BBA pays interest of 6% per year on its debt. What is its annual interest tax shield? b) What is the present value of the interest tax shield, assuming the tax shield’s risk is the same as that of the loan? c) Suppose instead that the interest rate on the debt is 5%. What is the present value of the interest tax shield in this case? Ten years have passed since BBA issued $10 million in perpetual interest-only debt with a 6% annual coupon. Tax rates have remained the same at 30% but interest rates have dropped so BBA’s current cost of debt capital is 4%. d) What is BBA’s annual interest tax shield now? e) What is the present value of the interest tax shield now?arrow_forwardThe Cost of Debt and Flotation Costs. Suppose a company will issue new 20-year debt with a par value of $1,000 and a coupon rate of 8%, paid annually. The issue price will be $1,000. The tax rate is 25%. If the flotation cost is 2% of the issue proceeds, then what is the after-tax cost of debt? Round your answer to two decimal places. % What if the flotation costs were 11% of the bond issue? Round your answer to two decimal places. %arrow_forward
- Manshukharrow_forwardAvicorp has a $14.3 million debt issue outstanding, with a 5.9% 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. --- a. The cost of debt is% per year. (Round to four decimal places.) b. If Avicorp faces S a 40% tax rate, the after-tax cost of debt is %. (Round to four decimal places.) Time Remaining: 00:32:02 Nextarrow_forwardBraxton Enterprises currently has debt outstanding of $30 million and an interest rate of 10%. Braxton plans to reduce its debt by repaying $6 million in principal at the end of each year for the next five years.If Braxton's marginal corporate tax rate is 21%, what is the interest tax shield from Braxton's debt in each of the next five years? The interest tax shield in year one is how much in millions (Round to three decimal places.) The interest tax shield in year two is how much in millions (Round to three decimal places.) The interest tax shield in year three is how much in millions (Round to three decimal places.) The interest tax shield in year four is how much in millions (Round to three decimal places.) The interest tax shield in year five is how much in millions (Round to three decimal places.)arrow_forward
- A company expects EBIT of 200000 every year into perpetuity. The firm currently has no debt, but it can borrow at 10% per annum. The company's cost of equity is 25% and the company is subject to a corporate tax rat of 35%. If the company borrows 200,000 and uses the proceeds to repurchase equity, the value of the company would be:arrow_forwardOne of the advantages of borrowing is that interest is deductible for income tax purposes.a. If a company pays 8 percent interest to borrow $500,000, but is in an income tax bracket thatrequires it to pay 40 percent income tax, what is the actual net-of-tax interest cost that thecompany incurs?b. What is the effective interest rate that is paid by the company?arrow_forwardQ. Emmar Industries borrows $800 million at an interest rate of 7.6%. Emmar will pay tax at an effective rate of 35%. What is the present value of interest tax shields if?(a.) It expects to maintain this debt level into the far future?(b.) It expects to repay the debt at the end of 5 years?(c.) It expects to maintain a constant debt ratio once it borrows the $800 million and rassets =10%?arrow_forward
- ECB borrows $1,000,000 USDs by issuing 6-year bonds. ECB's cost of debt is 5%, so it will need to pay $50,000 USDs in interest each year for the next 6 years, and then repay the principal $1,000,000 USD in year 6. ECB's marginal tax rate will remain 35% throughout this period. By how much (in USDs) does the interest tax shield increase the value of ECB? Note: Express your answers in strictly numerical terms. For example, if the answer is $500, enter 500 as an answer.arrow_forwardThe firm's tax rate is 40%. The firm plans to sell bonds having a par value of $1,000. The coupon rate would be 8%, paid in a single payment each year. The time to maturity would be 30 years. The firm believes that it can sell these bonds for $1,200, and that it will incur flotation costs of $15 per bond. What is the firm's after-tax cost of debt?arrow_forwardICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with nine years to maturity that is quoted at 117 percent of face value. The issue makes semiannual payments and has an embedded cost of 11 percent annually. What is the company’s pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Pretax cost of debt % If the tax rate is 34 percent, what is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Aftertax cost of debt %arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
- Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education
Essentials Of Investments
Finance
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:9780134897264
Author:KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...
Finance
ISBN:9781337395250
Author:Eugene F. Brigham, Joel F. Houston
Publisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...
Finance
ISBN:9780077861759
Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:McGraw-Hill Education