Global Products plans to issue long-term bonds to raise funds to finance its growth. The company has existing bonds that are similar to the bonds it expects to issue. The existing bonds have a face value of $1000, mature in 10 years, pay $60 interest coupon annually, and are currently selling for $1077 each. (Therefore, the current YTM on the bonds is 5 percent.) Assume that Global will issue the new bonds at an interest rate cost of 5 percent based on the current YTM on its existing bonds. Global's marginal tax rate is 40%. What is the after-tax cost of debt?
Debenture Valuation
A debenture is a private and long-term debt instrument issued by financial, non-financial institutions, governments, or corporations. A debenture is classified as a type of bond, where the instrument carries a fixed rate of interest, commonly known as the ‘coupon rate.’ Debentures are documented in an indenture, clearly specifying the type of debenture, the rate and method of interest computation, and maturity date.
Note Valuation
It is the process to determine the value or worth of an asset, liability, debt of the company. It can be determined by many processes or techniques. Many factors can impact the valuation of an asset, liability, or the company, like:
Global Products plans to issue long-term bonds to raise funds to finance its growth. The company has existing bonds that are similar to the bonds it expects to issue. The existing bonds have a face value of $1000, mature in 10 years, pay $60 interest coupon annually, and are currently selling for $1077 each. (Therefore, the current YTM on the bonds is 5 percent.) Assume that Global will issue the new bonds at an interest rate cost of 5 percent based on the current YTM on its existing bonds. Global's marginal tax rate is 40%. What is the after-tax cost of debt?
The after-tax cost of debt is the cost of debt to the issuer after taking into account the benefit of the tax deductibility of the interest payments. In other words, it is the interest rate that a company must pay on its debt after adjusting for the reduction in income taxes resulting from the tax-deductibility of the interest payments. Since interest payments are tax-deductible, a company can subtract the amount of taxes it would have to pay on the interest from the interest rate it must pay, to arrive at its after-tax cost of debt. This after-tax cost of debt is used in calculations such as the weighted average cost of capital (WACC), which is a measure of a company's overall cost of capital.
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