a. A $1,000 par value bond issued by Conseco Electronics has 16 years to maturity. The bond pays $78 a year in interest and is selling for $880. What is the approximate yield to maturity? b. If the firm is in a 30 percent tax bracket, what is the aftertax cost of the debt?

Question

a. A [latex]\$1,000[/latex] par value bond issued by Conseco Electronics has 16 years to maturity. The bond pays [latex]\$78[/latex] a year in interest and is selling for [latex]\$880[/latex]. What is the approximate yield to maturity?

b. If the firm is in a 30 percent tax bracket, what is the aftertax cost of the debt?

Accepted Answer

a. Approximate yield to maturity [latex]\left(\mathrm{Y}^{\prime} ight)=[/latex]

[latex]\frac{ ext { Annual interest payment }+\frac{ ext { Principal payment }- ext { Price of the bond }}{ ext { Number of years to maturity }}}{.6 ext { (Price of the bond) }+.4 ext { (Principal payment) }}[/latex]

For the bond under discussion, the approximate yield to maturity [latex]\left(\mathrm{Y}^{\prime} ight)[/latex] would be:

[latex] \begin{aligned} Y^{\prime} &=\frac{\$ 78+\frac{\$ 1,000-880}{16}}{{.6(\$ 880)+.4(\$ 1,000)}} \ &=\frac{\$ 78+\frac{\$ 120}{16}}{\$ 528+\$ 400} \ &=\frac{\$ 78+7.50}{\$ 928}=\frac{\$ 85.50}{\$ 928}=9.21 \% \end{aligned} [/latex]

[latex]\begin{aligned} ext { b.} \quad \mathrm{K}_{\mathrm{d}}( ext { aftertax cost of debt }) &=\mathrm{Y}( ext { yield })(1-\mathrm{T}) \ &=9.21 \%(1-.30) \ &=9.21 \%(.70) \ &=6.45 \% \end{aligned}[/latex]

Question 11.1: a. A $1,000 par value bond issued by Conseco Electronics has...

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