Please do not use a financial calculator I do not understand how to use it Quest
ID: 2726637 • Letter: P
Question
Please do not use a financial calculator I do not understand how to use it
Question
Olympic Sports has two issues of debt outstanding. One is a 9% coupon bond with a face value of $20 million, a maturity of 10 years, and a yield to maturity of 10%. The coupons are paid annually. The other bond issue has a maturity of 15 years, with coupons also paid annually, and a coupon rate of 10%. The face value of the issue is $25 million, and the issue sells for 94% of par value. The firm’s tax rate is 35%. (LO13-2)
a. What is the before-tax cost of debt for Olympic?
b. What is Olympic’s after-tax cost of debt?
Explanation / Answer
Particulars Case A Case B Coupon bond rate 9% 10% Face value 2,00,00,000 2,50,00,000 Maturity period 10 15 Yiel to maturity 10% Payment of coupons annually annually Selling percentage 94% Issue price 2,35,00,000 Cost to company before tax 10% 21% Cost to company after tax [YTM*(1-tax rate)] 7% 14% Cost to company via Yeild to Maturity Method. Case B YTM will equal to 2,35,00,000 Face value 2,50,00,000 Annual interest @ 10% 25,00,000 YTM x YTM=23500000 [sum of 2500000/(1+x)^1 for 15 years]+25000000/(1+x)^15 This will simplify as 25000000*15/(1+x)+25000000/(1+x)^15 This will further simplify as (25000000*15+25000000)/(1+x)^15 Solving numerator 40,00,00,000 Now final formula: 23500000 = 400000000/(1+x)^15 Taking (1+x)^15 on the left hand side (1+x)^15 = 400000000/23500000 (1+x)^15 = 17.0212766 x = 15th root of 17.0213-1 x = 1.208-1 x = 21%