Question

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 13 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has an embedded cost of 6 percent annually.

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

a) 6.20%

b) 5.51%

c) 5.46%

d) 4.99%

e) 5.25%

2) If the tax rate is 36 percent, what is the aftertax cost of debt? (Do not round your intermediate calculations.)

a) 2.59%

b) 3.36%

c) 3.53%

d) 3.49%

e) 3.19%

Answer 1

a.Information provided:

Face value= future value= $1,000

Time= 13 years*2= 26 semi-annual periods

Coupon rate= 6%/2= 3%

Coupon payment= 0.03*1,000= $30

Present value= 107%*1,000= $1,070

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

The below has to be entered in a financial calculator to compute the yield to maturity:

FV= 1,000

PV= -1,070

N= 26

PMT= 30

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

The value obtained is 2.63

The pretax cost of debt is 2.63%*2= 5.25%.

Hence, the answer is option e.

2.Afte tax cost of debt= Pretax cost of debt*(1- tax)

                                   = 5.25%*(1- 0.36)

                                   = 3.36%.

Hence, the answer is option b.

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