Question

Suppose we have a bond issue currently outstanding that has 20 years left to maturity. The coupon rate is 8%, and coupons are paid semiannually. The bond is currently selling for $828 per $1,000 bond. What is the cost of debt?

a. 8%
b. 9%
c. 10%
d. 11%
e. 1296

Answer 1

The answer is C.

Step-by-step explanation:

The coupon payment is annual, meaning it is being paid once a year.

N(Number of years/Number of periods) = 40(20 x 2)

I/Y(Yield-To-Maturity) = ?

PMT(coupon payment) = $40[(80÷2/100) x $1,000]

FV(Future value/Par value) =$1,000

PV(present value or market value) = -828

Now to solve this, lets use a financial calculator (e.g Texas BA II plus)

N= 40; I/Y = ?; PMT = $40; FV = $1,000; CPT PV = -828

The cost of debt is 5%

Note that this is for semiannual. The annual cost of debt is therefore, 10%(5% x 2)