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Chapter 4: Q10BP (page 364)

Russell Container Corporation has a \(1,000 par value bond outstanding with 30 years to maturity. The bond carries an annual interest payment of \)105 and is currently selling for $880 per bond. Russell Corp. is in a 40 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar. a. Compute the yield to maturity on the old issue and use this as the yield for the new issue. b. Make the appropriate tax adjustment to determine the aftertax cost of debt.

Short Answer

Expert verified

Yield to maturity is 11.6%.

After tax cost of debt is 6.96%

Step by step solution

01

a. Calculation of yield to maturity

Yield鈥�to鈥�maturity鈥�=Coupon+FV-PricenFV+Price2脳100=105+1000-880301000+8802脳100=105+4940脳100=11.6%

11.6% is the yield to maturity for the bond.

02

b. Calculation of after tax cost of debt

Kd(Cost of debt)=鈥�鈥�Yield(1 - Tax Rate)=11.6脳(1-40%)=11.6脳0.6=6.96%

The aftertax cost of debt is 6.96%.

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Most popular questions from this chapter

Five investment alternatives have the following returns and standard deviations of returns:

Alternatives

Returns:

Expected Value

Standard Deviation

A ....................... \( 5,000 \)1,200

B ....................... 4,000 600

C ....................... 4,000 800

D ....................... 8,000 3,200

E ....................... 10,000 900

Using the coefficient of variation, rank the five alternatives from the lowest risk to the highest risk

Murray Motor Company wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of \(2.50 per share, and the current price of its common stock is \)50 per share. The expected growth rate is 8 percent.

a. Compute the cost of retained earnings (Ke). Use Formula 11-5.

b. If a $3 flotation cost is involved, compute the cost of new common stock (Kn). Use Formula 11-6.

Question:Maxwell Communications paid a dividend of $3 last year. Over the next 12 months, the dividend is expected to grow at 8 percent, which is the constant growth rate for the firm (g). The new dividend after 12 months will represent D1. The required rate of return (Ke) is 14 percent. Compute the price of the stock (P0)

The Caffeine Coffee Company uses the modified internal rate of return. The firm has a cost of capital of 11 percent. The project being analyzed is as follows (\(26,000 investment):

Year

Cash flow

1

\)12,000

2

11,000

3

9,000

a. What is the modified internal rate of return? An approximation from Appendix B is adequate. (You do not need to interpolate.)

b. Assume the traditional internal rate of return on the investment is 17.5 percent. Explain why your answer in part a would be lower.

Exodus Limousine Company has $1,000 par value bonds outstanding at 10 percent interest. The bonds will mature in 50 years. Compute the current price of the bonds if the percent yield to maturity is

a. 5 percent.

b. 15 percent.
See all solutions

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