Engineers at a semiconductor company developed an improved front-end-of-line (FEOL) formulation process that requires an investment of $6 million. The company plans to issue $6 million worth of 10-year bonds that will pay interest of 6% per year, payable annually. If the company’s effective tax rate is 40%, what is the after-tax cost (i.e., interest rate) of the debt financing?
What will be an ideal response?
Before-tax bond annual interest = 6 million*0.06 = $360,000
Annual bond interest NCF = 360,000(1 – 0.4) = $216,000
Find i* using a PW relation
0 = 6,000,000 - 216,000(P/A,i*,10) - 6,000,000(P/F,i*,10)
i* = 3.60% per year
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