Question

ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with ten years to maturity that is quoted at 109.5 percent of face value. The issue makes semiannual payments and has an embedded cost of 8 percent annually.

What is the company’s pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
If the tax rate is 34 percent, what is the aftertax cost of debt?

Answer 1

Cost of debt is basically the YTM of issuance.

We need to calculate the YTM of the bond given in question. Exact YTM calculation needs use of Excel or Financial calculator. Manual calculation can only lead us to approxiamte value of YTM. Have showed you both. In case if you don't have access to Excel or financial calculator use approximate formula, which would lead you to a closer result.

Excel Calculation:

So, pretax cost of debt = 6.68% --> Answer.

In case of manual calculations, use YTM approximation formula:

C = 4, n = 20, F = 100, P = $109.5. On substituting these values. Approx YTM = 3.37% (semi-annual) --> to convert this to annual, multiply by 2. Annual YTM (or pretax cost of debt is then = 6.73%.

After tax cost of debt = Pretax cost of debt * (1 - Tax rate) = 6.68% * (1 - 34%) = 4.41% --> Answer