Question

Advance, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 11 years to maturity that is quoted at 101 percent of face value. The issue makes semiannual payments and has a coupon rate of 12 percent annually.

(a)	What is Advance’s pretax cost of debt? (Round your answer to 2 decimal places. (e.g., 32.16))

Pretax cost of debt

%

  

(b)	If the tax rate is 34 percent, what is the aftertax cost of debt? (Round your answer to 2 decimal places. (e.g., 32.16))

Aftertax cost of debt

%

Answer 1

a.

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =11x2

1010 =∑ [(12*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^11x2

k=1

YTM% = 11.84

b.

after tax cost of debt = YTM*(1-tax rate) = 11.84*(1-0.34)=7.81%