Cost of debt using both methods (YTM and the approximation formula) Currently, W
ID: 2617308 • Letter: C
Question
Cost of debt using both methods (YTM and the approximation formula) Currently, Warren Industries can sell 15-year, $1,000-par-value bonds paying annual interest at a 7% coupon rate. Because current market rates for similar bonds are just under 796, Warren can sell its bonds for $1,010 each; Warren will incur flotation costs of $30 per bond. The firm is in the 40% tax bracket. a. Find the net proceeds from the sale of the bond, N b. Calculate the bond's yield to maturity (YTM) to estimate the before-tax and after-tax costs of debt. c. Use the approximation formula to estimate the before-tax and after-tax costs of debt. a. The net proceeds from the sale of the bond, Nd, is (Round to the nearest dollar.)Explanation / Answer
a. Net Proceeds from the sale of bond $ 980 Working: Net Proceeds from the sale of bond = Selling Price of bond - Flotation cost = $ 1,010 - $ 30 = $ 980 b. Yield to Maturity = =rate(nper,pmt,-pv,fv) Where, = =rate(15,70,-980,1000) nper 15 = 7.22% pmt $ 70 pv $ 980 fv $ 1,000 Before tax yield to maturity = 7.22% After tax yield to maturity = Before tax Yield to Maturity*(1-Tax Rate) = 7.22% x (1-0.40) = 4.33% c. Yield to maturity = Average Income / Average Investment = (70+(1000-980)/15)/((1000+980)/2) = 7.21% Before tax yield to maturity = 7.21% After tax yield to maturity = Before tax yield to maturity*(1-Tax Rate) = 7.21% x (1-0.40) = 4.33% Working: Annual Coupon = Par Value x Annual Coupon rate = $ 1,000 x 7% = $ 70