Avicorp has a $ 10.1 million debt issue outstanding, with a 5.9 % coupon rate. The debt has semi-annual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 95 % of par value. a. What is Avicorp's pre-tax cost of debt? Note: Compute the effective annual return. b. If Avicorp faces a 40 % tax rate, what is its after-tax cost of debt? Note: Assume that the firm will always be able to utilize its full interest tax shield. a. The cost of debt is nothing% per year. (Round to four decimal places.) b. If Avicorp faces a 40 % tax rate, the after-tax cost of debt is nothing%. (Round to four decimal places.)

Explanation:

a). To find the pre-tax cost of debt, we need to put the following values in the financial calculator:

N = 5 x 2 = 10;

PV = -94% x $10,100,000 = -9,494,000

PMT = (5.9%/2) x 10,100,000 = 297,950;

FV = 10,100,000;

Press CPT, then I/Y, which gives us 3.6779

So, Periodic Rate = 3.6779

Hence, Pre-tax Cost of Debt = [1 + Periodic Rate]No. of compounding periods in a year - 1

= [1 + 0.036779]2 - 1 = 1.074911 - 1 = 0.074911, or 7.4911%

b). After-tax cost of debt = Pre-tax cost of debt x (1 - t)

= 7.4911% x (1 - 0.40) = 4.4947%

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