Question

Calculating Cost of Debt:

WUC Window, Inc., is trying to determine the cost of its debts. The firm has a debt  issue outstanding with seven years to maturity that is quoted at 108 percent of face value.  The issue makes semiannual payments and has embedded cost of 6.1 annually.

a) What is a WUC"s pretax cost of debt?

b) If the tax rate is 38 percent, what is the after-tax cost of debt?

Answer 1

The cost of debt is important for a company to know, so they can understand their valuation of the company. 

a) to find the pre-tax cost of debt

(Total interest cost incurred / Total debt) x 100

= (6.1 +(108-100)) / (208 / 2)

= (6.1 +8) / (104)

= 14.1 / 104 

Pretax cost of debt = .135576 or 13.56%

 

b) to find the after tax cost of debt

= .1356 ( 1- .38)

= .1356 x .62

After tax cost of debt  = .084072 or 8.41%

a) The pre-tax cost of debt is 13.56% or .135576.

b) The after tax cost of debt is 8.41% or .084072