SOLUTION: In March of 2020 PepsiCo, Inc. (PEP) sold $750million worth of 40-year 3.875% coupon bonds that pay semi-annual interest. At the time the bonds were issued, the market paid $994.20
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Question 1193881: In March of 2020 PepsiCo, Inc. (PEP) sold $750million worth of 40-year 3.875% coupon bonds that pay semi-annual interest. At the time the bonds were issued, the market paid $994.20 per bond and the flotation cost was $18.76 per bond. Pepsi’s corporate tax rate is 21%.
a. Ignoring flotation costs, what is Pepsi’s before-tax and after-tax costs of debt?
b. Considering flotation costs, what is Pepsi’s before-tax and after-tax costs of debt?
Answer by parmen(42) (Show Source): You can put this solution on YOUR website!
**a. Ignoring Flotation Costs**
* **Before-tax Cost of Debt (Approximate):**
- The approximate before-tax cost of debt can be estimated using the following formula:
Before-tax Cost of Debt ≈ (2 * Annual Coupon Payment) / Bond Price
- Annual Coupon Payment = Coupon Rate * Face Value
= 0.03875 * $1000
= $38.75
- Before-tax Cost of Debt ≈ (2 * $38.75) / $994.20
≈ 0.0779 or 7.79%
* **After-tax Cost of Debt:**
- After-tax Cost of Debt = Before-tax Cost of Debt * (1 - Tax Rate)
= 0.0779 * (1 - 0.21)
= 0.0779 * 0.79
= 0.0616 or 6.16%
**b. Considering Flotation Costs**
* **Before-tax Cost of Debt (Approximate):**
- The approximate before-tax cost of debt considering flotation costs can be estimated using the following formula:
Before-tax Cost of Debt ≈ (2 * Annual Coupon Payment) / (Bond Price - Flotation Cost)
Before-tax Cost of Debt ≈ (2 * $38.75) / ($994.20 - $18.76)
≈ 0.0791 or 7.91%
* **After-tax Cost of Debt:**
- After-tax Cost of Debt = Before-tax Cost of Debt * (1 - Tax Rate)
= 0.0791 * (1 - 0.21)
= 0.0791 * 0.79
= 0.0625 or 6.25%
**Note:**
* These calculations provide approximate values for the before-tax and after-tax costs of debt.
* For a more precise calculation of the before-tax cost of debt, you would need to use financial software or a financial calculator to determine the yield to maturity (YTM) of the bond. The YTM is the internal rate of return that equates the present value of the bond's future cash flows (coupon payments and principal repayment) to its current market price.
I hope this helps!
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