"Corporate Finance":Examples of matrix pricing

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Questions 1:

Which of the following is most likely considered an example of matrix pricing when determining the cost of debt?

A、 Debt-rating approach only.

B、 Yield-to-maturity approach only.

C、 Both the yield-to-maturity and the debt-rating approaches.

Questions 2:

A company recently issued a 10-year, 6% semiannual coupon bond for $864. The bond has a maturity value of $1,000. If the marginal tax rate is 35%, the after-tax cost of debt (%) is closest to:

A、 3.9%.

B、 5.2%.

C、 2.6%.

View answer resolution

【Answer to question 1】A

【analysis】

A is correct. The debt-rating approach is an example of matrix pricing.

B is incorrect because the yield-to-maturity approach is not an example of matrix pricing.

C is incorrect because the yield-to-maturity approach is not an example of matrix pricing.

【Answer to question 2】B

【analysis】

B is correct. The pre-tax cost of debt is the yield to maturity (YTM) of the bond. The bond’s YTM can be calculated by solving the following equation for i:

Corporate Finance:Examples of matrix pricing

Using a financial calculator, enter N = 20 (semiannual periods), w = –864, PMT = 30, and FV = 1,000. Compute I/YR. The six-month yield (or calculated I/YR) is 4%. The YTM is obtained by doubling the six-month yield to get 8%. Multiplying the pre-tax cost of debt by (1 – Tax rate) gives the result of 8 × (1 – 0.35) = 5.2%.

A is incorrect. If the after-tax amount of the coupon rate is used, the result will be 0.06(1 – 0.35) = 3.9%.

C is incorrect. If the after-tax cost for six-month yield is used, the result will be 0.04(1 – 0.35) = 2.6%.

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