Olympic Sports has two issues of debt outstanding. One is a 6% coupon bond with a face value of $39 million, a maturity of 10 years, and a yield to maturity of 7%. 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 7%. The face value of the issue is $44 million, and the issue sells for 90% of par value. The firm's tax rate is 35%. a. What is the before-tax cost of debt for Olympic?b. What is Olympic's after-tax cost of debt?

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Asked Feb 16, 2020
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Olympic Sports has two issues of debt outstanding. One is a 6% coupon bond with a face value of $39 million, a maturity of 10 years, and a yield to maturity of 7%. 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 7%. The face value of the issue is $44 million, and the issue sells for 90% of par value. The firm's tax rate is 35%.

 

a. What is the before-tax cost of debt for Olympic?

b. What is Olympic's after-tax cost of debt?

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Expert Answer

Step 1

Given,

Bond one: Coupon rate =6%, face value =$39 million, maturity period =10 years, YTM=7%, paid annually.

Another Bond : Coupon rate =7%, face value =$44 million, maturity period =15 years, YTM=? current price of bond = 39.6 (selling at 90% of face value), paid annually.

Required to calculate: before and the after-tax cost of debt for Olympic.

YTM is considered as r = cost of debt, for bond one YTM is already given so here we need to calculate YTM=r for another bond.

 

Step 2

r=YTM= cost of debt can be calculated manually as well as using the RATE function of Excel, here we are using Excel:

Put the following values while using rate function:

Finance homework question answer, step 2, image 1

Finance homework question answer, step 2, image 2

Put the following values while using rate function,

Nper = total number of payment periods =15

Pmt = payment for each period =44*7% =3.08

Pv = current price of bond, always write it in =-39.6

FV = Value at maturity here it is face value =44

Type = 0

Guess = does not require

=RATE(15,3.08,-39.6,44,0)

=8.18%

YTM= 8.18% after rounding off it will be 8%

Step 3

a)Now pre-tax cost of debt for Olympic can be calculated follows:

pre-tax cost of debt = cost of debt for bond one + cost of debt for bond two

                               &n...

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