Question

Defense Electronics, Inc. (DEI), a large publicly traded firm is the market share leader in radar detection systems (RDSs), has asked you to compute the cost of debt for the firm. The cost of debt is equivalent to the required return to debtholders, or the firm’s YTM. Using the information provided below, compute the firm’s cost of debt and the total market value of the firm’s debt.

Debt:    230,000 7.2 percent coupon bonds outstanding, 25 years to maturity, selling for 108 percent of par; the bonds have a $1,000 par value each and make semiannual coupon payments.

Answer 1

semiannual interest = 1000 * .072 *6/12 = 36

semiannual months = 25*2=50

issue price = 1000*108% =1080

Yield to maturity = [interest + (Face value - price)/semiannual months ]/[(face value +price)/2]

         =[36+(1000-1080)/50]/[(1000+1080)/2]

          =[36+ (-80/50)]/[2080/2]

          =[36 - 1.6]/1040

          = 34.4/1040

          = .0331 or 3.31% semiannually (approx to 3.18% using financial calculator)

Annual yield to maturity = 3.31 *2 = 6.62%       (3.18*2=6.36%)

cost of debt = 6.62%

2)market value of debt = market price* number of bonds

         = 1080 *230000

            = $ 248,400,000