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16 December, 01:11

PackMan Corporation has semiannual bonds outstanding with nine years to maturity and the bonds are currently priced at $754.08. If the bonds have a coupon rate of 7.25 percent, what is the after-tax cost of debt for PackMan if its marginal tax rate is 30 percent.

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  1. 16 December, 02:34
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    8.23%

    Explanation:

    Since this bond pays semi-annual coupons, it means that the payments occur every 6 months; making it 2 periods per year. Using a Financial calculator; enter the following inputs. If using TI BA II plus, key in the number first, then the function.

    Total duration; N = 9*2 = 18

    Face Value; FV = 1,000 (use 1,000 if the value is not given)

    Present value or price; PV = - 754.08

    Semiannual Coupon Payment; PMT = Semiannual coupon rate * Face value

    Semiannual Coupon Payment; PMT = (7.25%/2) * 1000 = 36.25

    The Yield to maturity; YTM is the annual pretax I/Y which is the Pretax cost of debt in this case

    therefore, CPT I/Y = 5.875% (note: semi-annual rate)

    Next, convert the semiannual rate to annual rate i. e the YTM;

    = 5.875%*2

    Pretax cost of debt (YTM) = 11.75%

    Aftertax cost of debt = Pretax cost of debt (1-tax)

    = 0.1175% (1-0.30)

    = 0.08225 or 8.23%
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