Question

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 8 years to maturity that is quoted at 96 percent of face value. The issue makes semiannual payments and has an embedded cost of 8 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 35 percent, what is the aftertax cost of debt? (Do not round your intermediate calculations.)

Answer 1

a. Pretax cost of debt is computed as shown below:

Just plug the below figures in the financial calculator:

N = 16 (8 x 2)

PMT = 40 (8% / 2 x 1,000)

PV = - 960 (1,000 x 96%)

FV = 1,000

Now, press CPT and then I/Y. It will give I/Y equal to

= 4.352259982%

Now we need to multiply the above rate by 2 to get it on annual basis as shown below:

= 4.352259982% x 2

= 8.70% Approximately

b. The after tax cost of debt is computed as follows:

= 4.352259982% x 2 x (1 - 0.35)

= 5.66% Approximately

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