Question
Sincere Stationary Corp needs to raise $500,000 to improve its manufacuring plant. It has deceided to issue a $1,000 par value bond with a 14 % annual coupon rate and a 10 yr maturity. The investors require a 9% rate of return.
a. Compute the market value of the bond
b. What will the net price be if flotation costs are 10.5 % of the market price?
c. How many bonds will the firm have to issue to receive the needed funds?
d. What is the firm's after tax cost of debit if its average tax rate is 25% and its marginal tax rate is 34 percent?
Explanation / Answer
According to the given information, Amount needs to be raised = $500,000 Face value of the bond = $1,000 Coupon rate = 14% Required rate of return = 9% Years to maturity = 10 a) Computing the market value of the bond using excel sheet: Annual coupon payment = Face value of the bond * Annual coupon rate = $1,000 * 0.14 = $140 Step1: Go to excel and click "insert" to insert the function. Step2: Select the "PV" function as we are finding the current price of the bond or the present value of the bond in this case. Step3: Enter the values as Rate = 9%; Nper = 10; PMT = -140; FV = -1000 Step4: Click "OK" to get the desired value. The value comes to " $1,320.88" Therefore, the market value of the bond is $1,320.88 b) If the flotation costs are 10.5% of the market price, then the net market price will be calculated as the Actual market price minus the amount of flotation costs of the market price. Net price = $1,321 - 0.105 ($1321) = $1321 - 138.7 = $1,182 Therefore, the net market price of the bond is $1,182 c) Number of bonds to be issued = Amount needs to be raised / Net market price of the bonds = $500,000 / $1,182 = 423 bonds Therefore, the number of bonds to be issued are 423 d) When calculating the after-tax cost of debt, we consider the marginal tax rate which is 34% After-tax cost of debt = Before-tax cost of debt (1 - Marginal tax rate) = 9% (1 - 0.34) = 0.0594 or 6%