[indyc]

Problem 11-4
par value $1,000.00
interest 7% 70.00
years 15
mrkt price $958.00
flotation 11.00%
tax rate 18.00%

Net price = 852.62

Cost = __________

A-T Cost =__________





where I am now:


1070
-------
(1 + Rd)15

but don't know how to find the Rd, so that I can find the Kd

70+1000= 1070

1070
-------
(1 + Kd)15

[ArcSine]

Here's the basic set-up: The question is asking for the after-tax cost of the debt ("A-T", as you've named it). The "cost" of debt can be thought of as the effective interest rate the issuing company is paying for having issued the bonds.

The answer comes from finding the discount rate which makes the NPV of the cash outflows equal to the initial cash inflow. The initial amount received is the amount net of flotation costs, or 852.62, as in your given info.

As to the cash outflow stream, you've actually got two: (1) The company will make a $70 coupon payment every year (I'm assuming annual, based on how you presented your info, but make sure it's not $35 semiannually). It will then redeem the debt at the end of Year 15, paying $1,000. Putting it together, you've got 14 annual payments of $70, and then a single payment of $1,070.

(2) There's another cash flow stream, which is the tax savings of the issuer's interest expense. This can be treated as an inflow, as it represents a reduction of the issuer's overall tax bill each year. Here's where you'll have to do a bit of digging in your text to find the method for computing the company's annual tax deduction. There are a number of ways to figure it, and it'll be more efficient if you'll check your text to see what method is called for.

Putting (1) and (2) together will give you 15 annual amounts. The first 14 are each $70, less the tax savings for each year (which might be different, depending on the text's method for figuring the tax deduction). The 15th amount is $1,070, less the 15th year's tax savings.

The answer to your question, then, is the single discount rate which causes the NPV of your 15-year cash flow stream--as you've set it up as per above--to equal $852.62. Unfortunately, trial-and-error is the only procedure. But on the bright side, if you set your cash flow stream up on a spreadsheet, you can zip through the T&E iterations without breaking a sweat. (In fact, Excel has a utility "Goal Seek", and a built-in function "IRR", either of which will do the T&E passes for you in a snap.)

Check back in if you're still having troubles with it, and best of luck.