Question

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 10 years to maturity that is quoted at 97 percent of face value. The issue makes semiannual payments and has an embedded cost of 12 percent annually. Required: (a) What is the company's pretax cost of debt? (Do not round your intermediate calculations.) (b) If the tax rate is 37 percent, what is the aftertax cost of debt? (Do not round your intermediate calculations.)

Answer 1

Information provided:

Future value= $1,000

Present value= 97% of 1,000= 970

Coupon rate= 12%/2= 6%

Coupon payment= 0.06*1,000= $60

Time= 10 years*2= 20 semi-annual periods

The pretax cost of debt is calculated by computed the yield to maturity.

The yield to maturity is computed by entering the below in a financial calculator:

FV= 1,000

PV= -970

PMT= 60

N= 20

Press the CPT key and I/Y to calculate the yield to maturity.

The value obtained is 5.7564% per semi-annual periof and 5.7564%*2= 11.5128% for a year.

Therefore, pretax cost of debt is 11.5128% 11.51%

The after tax cost of debt= pretax cost of debt(1- tax)

                                                = 11.5128%*(1-0.37)

                                                = 11.5128%*0.63

                                                = 7.2531%.

Therefore, the after tax cost of debt is 7.2531% 7.25%