Question

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 15 years to maturity that is quoted at 102 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? 9.11% 9.20% 8.32% 8.76% If the tax rate is 33 percent, what is the aftertax cost of debt? 5.57% 6.10% 5.87% 6.16% 4.78%

Answer 1

Face Value = $1,000
Current Price = 102%*$1,000 = $1,020

Annual Coupon Rate = 9%
Semiannual Coupon Rate = 4.50%
Semiannual Coupon = 4.50%*$1,000 = $45

Time to Maturity = 15 years
Semiannual Period to Maturity = 30

Let semiannual YTM be i%

$1,020 = $45 * PVIFA(i%, 30) + $1,000 * PVIF(i%, 30)

Using financial calculator:
N = 30
PV = -1020
PMT = 45
FV = 1000

I = 4.379%

Semiannual YTM = 4.379%
Annual YTM = 2 * 4.379%
Annual YTM = 8.76%

Before-tax Cost of Debt = 8.76%
After-tax Cost of Debt = 8.76% * (1 - 0.33)
After-tax Cost of Debt = 5.87%