Question

Gilbert Inc. has bonds outstanding that were issued 10 years ago with an original maturity of 20 years. These pay interest semiannually, and have a fixed coupon of 7.50%. Today, each $1000 face value bond is selling for $1030. Gilbert’s marginal tax rate is 25%. Assuming Gilbert would like to issue new bonds today that have the same remaining maturity as their existing bonds, we can estimate Gilbert’s pre-tax marginal cost of debt to be: 7.66% 7.97% 6.49% 6.73% 7.08%

Answer 1

Given about Gilbert Inc.'s bond,

current price = $1030

Face value = $1000

coupon rate = 7.50% paid semiannually

So, semiannual coupon = (7.5%/2) of 1000 = $37.5

years to maturity = 10 years,

Yield to maturity of the bond can be calculated on financial calculator using following values:

FV = 1000

PV = -1030

PMT = 37.50

N = 2*10 = 20

Compute for I/Y, we get I/Y = 3.538

So, YTM of the bond = 2*3.538 = 7.08%

For a company, its pretax cost of debt Kd equals its bond's YTM

So, company's pretax cost of debt Kd = 7.08%

Option E is correct.