The After-Tax Cost of Capital for Bonds for the Maximus Corporation

 

The After-Tax Cost of Capital for Bonds for the Maximus Corporation
To calculate the after-tax cost of capital for bonds, we need to consider several factors: the selling price of the bonds, the par value of the bonds, the coupon interest rate, the maturity period of the bonds, and the tax rate. Let’s break down the calculations step by step.

Calculate the annual interest payment:
Coupon interest rate: 10%
Par value of the bonds: $1,000
The annual interest payment can be calculated by multiplying the coupon interest rate by the par value of the bonds:

Annual interest payment = Coupon interest rate * Par value of bonds Annual interest payment = 10% * $1,000 Annual interest payment = $100

Calculate the after-tax cost of debt:
Selling price of the bonds: $920
Tax rate: 34%
The after-tax cost of debt can be calculated using the following formula:

After-tax cost of debt = (Annual interest payment * (1 – Tax rate)) / Selling price of bonds

After-tax cost of debt = ($100 * (1 – 0.34)) / $920 After-tax cost of debt = $66 / $920 After-tax cost of debt ≈ 0.0717 or 7.17%

Therefore, the after-tax cost of capital for the bonds issued by the Maximus Corporation is approximately 7.17%.

This means that Maximus can expect to pay an annual interest payment of $100 per bond to its bondholders, and after accounting for the tax savings due to the tax-deductible nature of interest payments, the after-tax cost of financing this debt is 7.17% based on the selling price of the bonds.

It is important for Maximus to consider this after-tax cost of capital when evaluating the feasibility of the new investment. By understanding and considering the after-tax cost of capital, Maximus can make informed decisions about financing their project and ensure that it aligns with their overall financial goals and objectives.

Overall, calculating the after-tax cost of capital for bonds allows companies like Maximus to evaluate the financial implications of issuing debt and make informed decisions regarding their financing strategies.