Joined: 26 Aug 2009
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Posted: 31 Aug 2009 at 15:10 | IP Logged
can someone help with this???
Ex A firm sells some 25 year bonds at par of $1,000. Flotation costs are 1.5% of par. The coupon rate is 12%. Find the before tax cost of debt? Net proceeds = $1,000 - (1,000 X .015) = $985
Joined: 05 Jun 2009 Location: United States
Online Status: Offline Posts: 1145
Posted: 31 Aug 2009 at 15:37 | IP Logged
cash received par less flotation costs = 985 as shown above. This is the portion of bond proceeds that are actually usable by the company. Interest paid each year = .12*1000 = 120 In effect, you pay interest of $12 per year for usable receipts of $985, so cost before tax is 120/985 = 12.1827%
There is a question in Gleim asking us to compute WACC.
Details given are: Bonds have a 9% coupon rate and will net $19.2 million after flotation costs.
Preferred stock with a stated rate of 6% that will yield $4.8 million after a 4% flotation cost.
In the answer, to compute cost of debt, they have simply taken post-tax on the 9%. They have not computed effective int rate for the bonds. But to compute cost of preferred stock, they have considered flotation costs.
They write "Flotation costs are ignored for bonds because $20 million must be repaid on the maturity date, which is not the case for preferred stock"
From what I remember reading, flotation costs should be considered for bonds as well. The first question on this post also follows that rule.
Does anyone agree with Gleim here?
__________________ Jas, Jersey City, NJ
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Topic: Before tax cost of Debt????
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