Jimstan & Jimstan Corp. can sell a new 10-year bond with an annual coupon of 5.5% and a face value of $1,000 for $1,206.33. The company will incur flotation costs of $40 per bond and has a tax rate of 27%.

Part 1

What are the net proceeds from selling the bond?

Nd=PF=1,206.3340=Nd=P-F=1,206.33-40= 1,166.33 Correct

Part 2

What is the company's pre-tax cost of debt?

The cost of debt is

that discount rate that equates the net proceeds to the present value of the expected cash flows.

Nd=Crd[11(1+rd)n]+F(1+rd)nNd=Crd[1-1(1+rd)n]+F(1+rd)n

1,166.33=55rd [11(1+rd)10]+1,000(1+rd)101,166.33=55rd [1-1(1+rd)10]+1,000(1+rd)10

Unfortunately, this equation is non-linear in rdrd and cannot be solved for it. Instead, we have to use trial and error, a financial calculator or Excel.

Using a financial calculator:

	N	I/Y	PV	PMT	FV
Inputs	10		-1,166.33	55	1,000
Compute		3.5

Note that the net proceeds (the PV) must be entered as a negative number. Calculating I/Y gives a value of 3.5%, or 0.035.

Using Excel (do not enter the thousand separators): =RATE(nper, pmt, pv, fv) =RATE(10, 55, -1,166.33, 1,000) =0.035 Correct

Part 3

What is the company's after-tax cost of debt?