AAA has only stock and bonds in its capital structure. Balance sheet information

Question

AAA has only stock and bonds in its capital structure. Balance sheet information: Long term debt (par value--NOT number of bonds) = $20,000,000, Common equity and retained earings = $17,000,000, and Shares of stock outstanding = 1,000,000. Bond information: Bond price ($1,000 par value per bond) = $1,200.00, bond annual coupon rate with semiannual payments = 6.0%, and bond maturity = 10 years. Stock information: Stock price = $40.00, beta = 1.25, recent dividend (D0) = $3.00, dividend growth rate = 4.00%. Other information: risk free rate = 4.0%, the market risk premium = 6.5%, tax rate = 40.0%. Find the company's after-tax required return on debt

Explanation / Answer

semiannual payments = 6%*1000/2 =30 $1,200.00= 30/(1+r/2) +30/(1+r/2)^2 +30/(1+r/2)^3 .....................1030/(1+r/2)^20 r=3.601% after-tax required return on the debt=3.601%*(1-40.0%) =2.161%

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