Question
Asked Nov 22, 2019
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Simple Foods has a zero coupon bond issue outstanding that matures at nine years. The bonds are selling at 42% of par value. What is the company's after tax cost of debt if the tax rate is 38%? (Use semi annual compounding)

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Expert Answer

Step 1

The company has a zero coupon bond that matures in 9 years with semiannual compounding.

Par Value (FV) = $1,000

Price (P) = 42% * $1000 = $420

Semiannual YTM ( r ) = to be determined

Number of periods (n) = 9*2 = 18

Yield to maturity can be calculated as below:

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FV Price (1r) $1000 $420= (1+r)5 (1+r)2.38095238095238 1+r 1.0493747136612 r =0.0493747136612042

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Step 2

Annual YTM is semiannual YTM multiplied by 2.

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Annual YTM 0.0493747136612042 x2 9.87494273224083%

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Step 3

After tax cost of debt is c...

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After tax cost of debt = Annual YTM x(1 -tax rate) =9.87494273224083% x (1-0.38) 6.12246449398932% or 6.12%

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