Question

KatyDid Clothes has a $180 million (face value) 20-year bond issue selling for 105 percent of par that carries a coupon rate of 7 percent, paid semiannually.

What would be KatyDid's before-tax component cost of debt? (Round your answer to 2 decimal places.)

Cost of debt

%

Answer 1

Face value=$180 million=$180*1000000=$180000000
The bond is issuing at 105%, this means that the present value of the bond=$180000000*105%=$189000000
Present value=$189000000

Time period=20 years, as the coupon is paid semiannually, number of periods=20*2=40
Coupon rate=7%, as it is paid semiannually, the semiannual coupon rate=7%/2=3.5%
Semiannual coupon payment=Face value*Coupon rate=$180000000*3.5%=$6300000

We have determined the value of yield to maturity (YTM) as 3.27%. This is semiannual YTM.
Annual YTM=3.27%*2=6.54%
Before-tax component cost of debt of a bond is its yield to maturity.
So, the before-tax component cost of debt=6.54%

Note: Present value is a cash outflow, so it is denoted with a negative sign in excel.