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 7 percent annually.

What is the company's pretax cost of debt? If the tax rate is 32 percent, what is the aftertax cost of debt?

Answer 1

Information provided:

Face value= future value= $1,000

Current price= present value= 109*$1,000= $1,090

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

Coupon rate= 7%/2= 3.5%

Coupon payment= 0.035*1,000= $35

Tax rate= 32%

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

Enter the below in a financial calculator to compute the yield to maturity:

FV= 1,000

PV= -1,090

N= 24

PMT= 35

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

The value obtained is 2.9703.

Therefore, the pretax cost of debt is 2.9703%*2= 5.9405%.

After tax cost of debt= before tax cost of debt*(1 – tax)

                                        = 5.9405*(1 – 0.32)

                                        = 4.0395%.

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