Question

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 12 years to maturity that is quoted at 109 percent of face value. The issue makes semiannual payments and has an embedded cost of 10 percent annually.

  

Required:

  

(a)	What is the company's pretax cost of debt? (Do not round your intermediate calculations.)
	Options: 9.21% 8.33% 10.20% 9.12% 8.77%

  

(b)	If the tax rate is 34 percent, what is the aftertax cost of debt? (Do not round your intermediate calculations.)
	Options: 6.08% 5.35% 5.50% 6.02% 5.79%

Answer 1

Information provided:

Face value= future value= $1,000

Present value= 109%*1,000= $1,090

Time= 12 years*2= 24 semi-annual periods

Coupon rate= 10%/2= 5% per semiannual period

Coupon payment= 0.05*1,000= $50

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

FV= 1,000

PV= -1090

N= 24

PMT= 50

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

The value obtained is 4.3892.

Therefore, the pretax cost of debt is 4.3892%*2= 8.77%.

Hence, the answer is option e.

b.After tax cost of debt= Before tax cost of debt*(1-tax)

                                            = 8.77%*(1-0.34)

                                            = 5.79%.

Hence, the answer is option e.

In case of any query, kindly comment on the solution.