Question

AC will be issuing bonds with a total face value of P10,000,000 at an issue price of P9,900,000. It will incur issuance
cost of P600,000. The bonds have a term of 10 years and a coupon rate of 12% payable quarterly. If the tax rate is
30%, what is the e ective cost of the bonds using the interpolation method? Use increments of 1%. 

Expert Solution

 Step 1

In this we have to calculate the yield to maturity of bond and calculate e ective cost of bonds.

 Step 2

Face value of bond=10000000

Price of bond=9900000-600000=9300000

Price of bond=9300000

Period of bond=10 years= 40 Quarters

Coupon rate=12%

Quarterly coupon=0.03 x 100000000=300000

Now price of bond is below par value 

 So yield to maturity will be above 12% 

Let consider r=13%

Quarterly will be =13/4=3.25%

1−(1+r)−n
= 1−1.0325
0.0325 = 22.208433237
−40
Present value factor= r
(1+r)n = 1.032540 + 300000 x 22.208433237=9444789.1691
Price of bond= Present value factor x coupon + Par value 10000000

Now consider r=14%

Quarterly=14/4=3.5%

Present value factor= 1−1. 035

0.035
−40
= 21.355072337
Price of bond=21.355072337 x 300000+ 10000000
40 =8932246.3831
1.035
By interpolation
9444789.1691−9300000
r=3.25+(3.5-3.25) 9444789.1691−8932246.3831 = 3.320622967
Yield to maturity=3.320622967 x 4=13.28%

E ective cost of bond= Yield to maturity (1-0.30)=13.28 (1-0.3)=9.296%

E ective cost of bond=9.296%

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