Question

Too Young, Inc., has a bond outstanding with a coupon rate of 6.3 percent and semiannual payments. The bond currently sells for $944 and matures in 20 years. The par value is $1,000. What is the company's pretax cost of debt? Multiple Choice 3.35% 6.90% 7.34% 6.82% 7.10%

Answer 1

Bond Coupon = 6.3 % payable semi-annually, Current Bond Price = $ 944 and Par Value = $ 1000

Remaining Tenure = 20 years or (20 x 2) = 40 half-years

Let the YTM be 2R %

Semi-Annual Coupon = 0.063 x 0.5 x 1000 = $ 31.5

Therefore, 944 = 31.5 x (1/R) x [1-{1/(1+R)^(40)}] + 1000 / (1+R)^(40)

Using EXCEL's Goal Seek Function/a financial calculator/ hit and trial to solve the above equation,we get:

R = 0.03409 or 3.409 %

Pre-Tax Cost of Debt = YTM = 2 x R = 2 x 3.409 = 6.818 % ~ 6.82 %

Hence, the correct option is (d)