Cost of debt using both methods Currently, Warren Industries can sell 15-year, $

Question

Cost of debt using both methods Currently, Warren Industries can sell 15-year, $1,000-par-value bonds paying annual interest at a 12% coupon rate. As a result of current interest rates, the bonds can be sold for $1,010 each; flotation costs of $30 per bond will be incurred in this process. The firm is in the 40% tax bracket.                                                                                                                                                      

a. Find the net proceeds from sale of the bond, Nd.                                                                                                                                                   

b. Show the cash flows from the firms point of view over the maturity of the bond.                                                                                                                                                     

Cost of debt using both methods Currently, Warren Industries can sell 15-year, $1,000-par-value bonds paying annual interest at a 12% coupon rate. As a result of current interest rates, the bonds can be sold for $1,010 each; flotation costs of $30 per bond will be incurred in this process. The firm is in the 40% tax bracket. Find the net proceeds from sale of the bond, Nd. Show the cash flows from the firm's point of view over the maturity of the bond.

Explanation / Answer

Currently, Warren Industries can sell 15-year, $1,000-par-value bonds paying annual interest at a 12% coupon rate. As a result of current interest
rates, the bonds can be sold for $1,010 each; flotation costs of $30 per bond will be incurred in this process. The firm is in the 40% tax bracket.
a. Find the net proceeds from sale of the bond, .
b. Show the cash flows from the firms point of view over the maturity of the bond.
c. Calculate the before-tax and after-tax costs of debt.
d. Use the approximation formula to estimate the before-tax and after-tax costs of debt.
e. Compare and contrast the costs of debt calculated in parts c and d. Which approach do you prefer? Why?
Period
Par value
Coupon

15
1000
12%

a. net proceeds
Current sale price
Less: Flotation cost
Net proceeds

1010
30
980

b.)Show the cash flows from the firms point of view over the maturity of the bond.

Year 0
Cash inflow
Years 1 to 14 Cash outflow
Year 15
Net cash outflow

$980
($120) each year
($1,120) ($120 coupon + $1000 maturity)

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