Question

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 11 years to maturity that is quoted at 110 percent of face value. The issue makes semiannual payments and has an embedded cost of 9 percent annually. Use TVM to solve part (A).

Required:

(a)	What is the company's pretax cost of debt? (Do not round your intermediate calculations.)

(b)	If the tax rate is 34 percent, what is the aftertax cost of debt? (Do not round your intermediate calculations.)

Answer 1

A.

We need to calculate YTM for this bond in order to calculate the YTM.

Assume face of the bond to be $100. This is the FV of bond as it would be paid on maturity

PV or the current price of bond is then $110.

Years to Maturity = 11. Number of periods (due to semi-annual payments) = 11*2 = 22

Coupon % = 9% = $9 annually. Hence $4.5 on semi-annual basis.

Given these information we need to calculate YTM.

Now, in order to solve YTM using financial calculator, do these inputs (after you clear your TVM memory of calculator) with profper signs:

FV = $100 (positive since it is inflow)

n = 22

PMT = $4.5 (positive since it is inflow)

PV = -$110 (negative since it is outflow)

We need to calculte "I/Y". This I/Y (when you calculate it) = 3.82%.

This rate is on semi-annual basis. Hence, YTM = 3.82% * 2 = 7.64%

B

Now, the YTM calculated above is pretax cost of debt

Post tax cost of debt = Pretax cost of debt * (1 - tax rate)

Post tax cost of debt = 7.64% * (1 - 34%) = 5.04%