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 103 percent of face value. The issue makes semiannual payments and has an embedded cost of 7 percent annually.
What is the company's pretax cost of debt? (Do not round your intermediate calculations.)

Answer 1

Answer:

pretax cost of debt: 6.633%

Explanation:

We have to solve for the interest rate at which the present value of the coupon payment and maturity matches the present value of the bonds.

This is done using excelor a financial calculation

Present value of the coupon payment (ordinary annuity)

$C \times \frac{1-(1+r)^{-time} }{rate} = PV$  

C 35  (1,000 x 7% / 2 payment per year)

time 24  ( 12 years x 2 payment per year)

rate 0.033167588

$35 \times \frac{1-(1+0.033167588)^{-24} }{0.033167588} = PV$  

PV $573.0155  

Present value of maturity (lump sum)

$\frac{Maturity}{(1 + rate)^{time} } = PV$  

Maturity   1,000.00  

time   24.00  

rate  0.033167588

$\frac{1000}{(1 + 0.033167588)^{24} } = PV$  

PV   456.98  

 

PV c $573.0155  

PV m  $456.9845  

Total $1,030.0000  

Notice this rate is given with semianual payment we should multiply by two to get the annual cost of debt:

0.033167588 x 2 = 0.06633