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At the present time, Western Gas & Electric Company (WGC) has 10-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,278.41 per bond, carry a coupon rate of 11%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 25%. If WGC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? (Note: Round your YTM rate to two decimal place.)

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Answer:

Explanation:

First, find the Pretax cost of debt i.e the YTM.

You can compute this using a financial calculator with the following inputs;

FV = 1,000

N= 10

PMT = 0.11*1000 = 110

PV = -1,278.41

then CPT I/Y = 7.03%

Therefore, the pretax cost of debt = 7.03%

Next, find after-tax cost of debt

After-tax cost of debt = pretax cost of debt (1-tax)

 = 7.03% (1-0.25)

 = 5.27%

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