Question

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 14 years to maturity that is quoted at 96 percent of face value. The issue makes semiannual payments and has an embedded cost of 9 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 34 percent, what is the aftertax cost of debt? (Do not round your intermediate calculations.)

Answer 1

a.Information Provided:

Face value= future value= $1,000

Present value= 96%*1,000= $960

Coupon arte= 9%/2= 4.50%

Coupon payment= 0.045*1,000= $45

Time= 14 years*2= 28 semi-annual periods

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= -960

PMT= 45

N= 28

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

The value obtained is 4.7616.

Therefore, the pretax cost of debt is 4.7616%82= 9.5231 9.52%.

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

                                    = 9.52%*(1-0.34)

                                     = 6.28%.

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