Corporate Finance

ankita.rehani
Posts: 4
Joined: Sat Nov 07, 2015 3:35 am

Corporate Finance

Postby ankita.rehani » Fri Jan 15, 2016 7:20 pm

A firm is determining the after tax cost of debt in its WACC calculation. It has recently issued a bond for $956 for 15 years with the semi-annual coupon payment of 10%. The bond has a face value of $1000. If the marginal tax is 35%, the after tax cost of debt will be? How to calculate semi annual interest?

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Re: Corporate Finance

Postby edupristine » Sat Jan 16, 2016 7:54 am

Cost of debt, can be calculated by two step approach:
1) We calculate annual yield to maturity for investor, which by
Equating Present value, i.e. 1000*97% with the semi-annual payments, we get annual yield maturity i.e. 10.592% (APR)
2) Now, from company’s point of view this cost shall be calculated considering the fact that they can deduct interest from taxable income.
Given the tax rate of 35%, we get , Cost of debt is given by, 10.592%*(1-.35)= 6.88%

ankita.rehani
Posts: 4
Joined: Sat Nov 07, 2015 3:35 am

Re: Corporate Finance

Postby ankita.rehani » Sat Jan 16, 2016 3:29 pm

How did you calculate annual yield to maturity? From where did 97% come?

ankita.rehani
Posts: 4
Joined: Sat Nov 07, 2015 3:35 am

Re: Corporate Finance

Postby ankita.rehani » Sat Jan 16, 2016 3:31 pm

edupristine wrote:Cost of debt, can be calculated by two step approach:
1) We calculate annual yield to maturity for investor, which by
Equating Present value, i.e. 1000*97% with the semi-annual payments, we get annual yield maturity i.e. 10.592% (APR)
2) Now, from company’s point of view this cost shall be calculated considering the fact that they can deduct interest from taxable income.
Given the tax rate of 35%, we get , Cost of debt is given by, 10.592%*(1-.35)= 6.88%


How did you calculate annual yield maturity? From where did 97% come?

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Re: Corporate Finance

Postby edupristine » Fri Jan 29, 2016 7:05 am

There was some clerical error, instead of 97%, it should be 95.6%. Basically by multiplying 1000 by 95.6% to get 956 we are finding present value which

is given in the question itself. Hence there was no need to calculate the same

Annual yield to maturity has been calculated using the following information: Pmt=50, Nper=30, PV=-956, FV=1000 to find rate which is multiplied by 2 to get 10.592%. In short we are trying to find the return in % terms to investor over the life of bond.
I hope the above helps.


Return to “CFA Level I”



cron

Disclaimer

Global Association of Risk Professionals, Inc. (GARP®) does not endorse, promote, review or warrant the accuracy of the products or services offered by EduPristine for FRM® related information, nor does it endorse any pass rates claimed by the provider. Further, GARP® is not responsible for any fees or costs paid by the user to EduPristine nor is GARP® responsible for any fees or costs of any person or entity providing any services to EduPristine Study Program. FRM®, GARP® and Global Association of Risk Professionals®, are trademarks owned by the Global Association of Risk Professionals, Inc

CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by EduPristine. CFA Institute, CFA®, Claritas® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

Utmost care has been taken to ensure that there is no copyright violation or infringement in any of our content. Still, in case you feel that there is any copyright violation of any kind please send a mail to abuse@edupristine.com and we will rectify it.