Question

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 12 years to maturity that is quoted at 94 percent of face value. The issue makes semiannual payments and has an embedded cost of 10 percent annually.

  

Required:

  

(a)	What is the company's pretax cost of debt? (Do not round your intermediate calculations.)
	(Click to select)11.45%10.20%10.36%11.34%10.91%

  

(b)	If the tax rate is 35 percent, what is the aftertax cost of debt? (Do not round your intermediate calculations.)
	(Click to select)7.37%5.25%7.45%6.74%7.09%

Answer 1

We need to calculate the YTM on the bond issue described on the question.

Exact YTM can be calculated only using either Excel or Financial calculator. For manual calculation, you will be able to calculate approx YTM only. I will show both the methods (but use the exact YTM for further calculations).

Exact calculation using Excel:

Manual calculation:

For manual calculation, formula is:

Try substituting values here, YTM = 5.41% --> semi-annual here. Annual YTM then would be (2 time) --> 10.82%

Hence, pretax cost of debt = 10.91% --> Answer

Post tax cost of debt = pretax cost * (1 - tax rate) = 10.91% * (1 - 35%) = 7.09% --> Answer