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Addison Glass Company has a $1,000 par value bond outstanding with 25 years to maturity. The bond carries an annual interest payment of $88 and is currently selling for $925. Addison is in a 25 percent tax bracket. The firm wishes to know what the after tax 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 approximate 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 after tax cost of debt.
In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market? Why?
Why is the cost of debt less than the cost of preferred stock if both securities are priced to yield 10 percent in the market?
Why is the cost of issuing new common stock (Kn) higher than the cost of retained earnings (Ke)?
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Solution Summary
The solution has the calculation for yield to maturity of a bond. The solution also explains how to compute cost of capital and the relation between cost of debt and cost of preferred stock, cost of new common stock and retained earnings.
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Addison Glass Company has a $1,000 par value bond outstanding with 25 years to maturity. The bond carries an annual interest payment of $88 and is currently selling for $925. Addison is in a 25 percent tax bracket. The firm wishes to know what the after tax 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 approximate yield to maturity on the old issue and use this as the yield for the new issue.
The YTM is the discount rate that makes the present value of the interest and principal payments equal to the price today. In this case, we have interest payment of $88 and principal repayment of $1,000. The interest payments are in the nature of an annuity and the present value can eb found by ...
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