P11-2 Cost of debt using both methods Currently, Warren Industries can sell 15-year, $1,000-part-value bonds paying annual interest at a 12% coupon rate. As a result of current interest rates, the bonds can be sold for $1,010 each; flotation costs of $30 per bond will be incurred in this process. The firm is in the 40% tax bracket.
a. Find the net proceeds from sale of bond, Nd.
b. Show cash flows from the firm's point of view over the maturity of the bond.
c. Use IRR approach to calculate the before-tax and after -tax costs of debt.
d. Use the approximation formula to estimate the before-tax and after-tax costs of debt.
e. Compare and contrast the costs of debt calculated in parts c and d. which approaches do you prefer? Why?
The solution explains how to calculate cost of debt using IRR formula and the approximation method
Debt-equity comparisons considering WACC, corporate tax, leverage, cost of debt
The book I am using is Fundamental of Corporate Finance, 4e
a) Why is debt a comparatively cheaper form of finance than equity?
b) If debt is cheaper than equity, why do companies approach the equity markets?
c) How can one minimize WACC when there is a constraint on raising debt? if so, how?
d) What are the effects of a corporate tax on the WACC of a business?
e) Is minimizing WACC by having a largely debt-based capital structure a high-risk strategy, given the threat of bankruptcy in an over-leveraged business? Explain your answer.
f) What are the extraneous factors which impact the ability of a business to radically alter its debt-equity mix?