Question

Contrail Air, Inc. is trying to determine its cost of debt. The company has an outstanding debt issue with 19 years to maturity that is quoted at 98.00% percent of face value. The issue makes semiannual payments and has a coupon rate of 9.00% percent. What is the pretax cost of debt?

Settlement	01/01/2000
Maturity	01/01/2019
Price (% of par)	98
Coupon rate	9%
Payments per year	2
Tax rate	40%

A)4.23%

B)9.85%

C)16.52%

D)8.25%

Answer 1

Face Value = $1,000

Current Price = 98% * $1,000
Current Price = $980

Annual Coupon Rate = 9%
Semiannual Coupon Rate = 4.50%
Semiannual Coupon = 4.50% * $1,000
Semiannual Coupon = $454

Time to Maturity = 19 years
Semiannual Period to Maturity = 38

Let Semiannual YTM be i%

$980 = $45 * PVIFA(i%, 38) + $1,000 * PVIF(i%, 38)

Using financial calculator:
N = 38
PV = -980
PMT = 45
FV = 1000

I = 4.613%

Semiannual YTM = 4.613%
Annual YTM = 2 * 4.613%
Annual YTM = 9.23%

Before-tax Cost of Debt = 9.23%