Question

Handy Man, Inc., has zero coupon bonds outstanding that mature in eight years. The bonds have a face value of $1,000 and a current market price of $640. What is the pretax cost of debt? (Use semiannual compounding.)

Answer 1

Answer:

5.657%

Explanation:

Data provided:

Face value = $1,000

Current market price = $640

Time of maturity, t = 8 year

Now,

the compounding formula is given as:

Face value = Current amount × $(1+\frac{r}{n})^{nt}$

where,

r is the rate i.e pretax rate of debt

n is the number of times the interest is compounded i.e for semiannual n = 2

thus, on substituting the values, we get

$ 1,000= $ 640 × $(1+\frac{r}{2})^{2\times8}$

or

1.5625 = $(1+\frac{r}{2})^{16}$

or

$(1+\frac{r}{2})$ = 1.0282

or

r = 0.05657

or

pretax cost of debt = 0.05657 × 100% = 5.657%