Question 1: Sullivan Cement Company can issue debt yielding 13 percent. The company is paying a 36 percent rate. What is the after-tax cost of debt?
Question 2: 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 (Formula 11-1) 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.
Question 3: Mead Corporation is planning to issue debt that will mature in 2025. In many respects the issue is similar to currently outstanding debt of the corporation.
a.) Identify the yield to maturity on similarly outstanding debt for the firm, in terms of maturity.
b.) Assume that because the new debt will be issued at par, the required yield to maturity will be 0.15 percent higher than the value determined in part a. Add this factor to the answer in a. (New issues at par sometimes require a slightly higher yield than old issues that are trading below par. There is less leverage and fewer tax advantages.)
c.) If the firm is in a 30 percent tax bracket, what is the after-tax cost of debt?
Question 4: As an alternative to the capital structure shown in problem 16 for Global Technology, an outside consultant has suggested the following modifications.
Debt 60%
Preferred stock 5
Common equity 35
Under this new and more debt-oriented arrangement, the after-tax cost of debt is 8.8 percent, the cost of preferred stock is 11 percent, and the cost of common equity (in the form of retained earnings) is 15.6 percent. Recalculate Global's weighted average cost of capital. Which plan is optimal in terms of minimizing the weighted average cost of capital?