Question

ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 8 years to maturity that is quoted at 106.5 percent of face value. The issue makes semiannual payments and has an embedded cost of 6.4 percent annually. a. What is the company’s pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. If the tax rate is 23 percent, what is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Cost of debt is the rate at which PV of Cash Outflows are equal to bond price.

Cost of Debt per 6 months = Rate at which least +ve NPV + [ NPV at that rate / chnage in NPV due to 0.5% inc in disc rate ] * 0.5%

= 2.5% + [ 26.39 / 66.26 ] * 0.5%

= 2.5% + 0.40 * 0.5%

= 2.5% + 0.20%

= 2.70%

Cost of Debt per anum = Cost of debt per 6 Months * 12 / 6

= 2.70% * 12 / 6

= 5.40%

Part B:

AFter tax cost of debt = Cost of debt * ( 1- Tax rate )

= 5.40% ( 1 - 0.23)

= 5.40% * 0.77

= 4.158%