Question

Espy Hotels has bonds outstanding that mature in 9 years, pay interest semiannually, and have a coupon rate of 5.5 percent. These bonds have a face value of $1,000 and a current market price of $989.28. What is the company's aftertax cost of debt if its tax rate is 22 percent

Answer 1

The company's after-tax cost of debt if its tax rate is 22 percent is equal to 3%.

What is the meaning of the cost of debt?

The effective rate that a company pays on its debt, such as bonds and loans is called as cost of debt.

As per the given information:

The face value of bond (FV) is $1,000

The coupon rate is 5.5%/2 will be 2.75%

$\rm\,Coupon \,Payment\, (PMT) = 0.0275 \times 1,000 = \ 27.5$

Present value of bond (PV) = $989.28

Maturity = 9 years*2 will be 18

We can compute yield or rate using spreadsheet =Rate(nper,pmt,-PV, FV)

Substituting the values we get,

= RATE(18,27.5,-989.28,1000)

Rate or yield is computed as 3%

The present value is negative as it is a cash outflow.

The cost of debt is 3%

The tax rate is 22%

$\rm\,After \,Tax \,Cost \,of\, Debt = 3\% \times (1 - 0.22)\\\\ = 2.34\%$

Hence, the after-tax cost of debt is equal to 2.34%

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