Question

J&R Renovation, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 20 years to maturity that is quoted at 108 percent of face value. The issue makes semiannual payments and has a coupon rate of 10 percent annually.

What is the company's pretax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Pretax cost of debt            %

If the tax rate is 35 percent, what is the aftertax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Aftertax cost of debt

Answer 1

Face Value = $1,000

Current Price = 108% * $1,000
Current Price = $1,080

Annual Coupon Rate = 10%
Semiannual Coupon Rate = 5%
Semiannual Coupon = 5% * $1,000
Semiannual Coupon = $50

Time to Maturity = 20 years
Semiannual Period to Maturity = 40

Let semiannual YTM be i%

$1,080 = $50 * PVIFA(i%, 40) + $1,000 * PVIF(i%, 40)

Using financial calculator:
N = 40
PV = -1080
PMT = 50
FV = 1000

I = 4.56%

Semiannual YTM = 4.56%
Annual YTM = 2 * 4.56%
Annual YTM = 9.12%

Pre-tax Cost of Debt = 9.12%

After-tax Cost of Debt = 9.12% * (1 - 0.35)
After-tax Cost of Debt = 5.93%