Question

Drogo, 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 110 percent of face value. The issue makes semiannual payments and has an embedded cost of 6 percent annually.

a. What is the company’s pretax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Pretax cost of debt %.
b. If the tax rate is 35 percent, what is the aftertax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Aftertax cost of debt %.

Answer 1

1. 4.89%

2. 3.18%

Step-by-step explanation:

In this question, we use the Rate formula which is shown in the spreadsheet.

The NPER represents the time period.

Given that,

Present value = $1,000 × 110% = $1,100

Assuming figure - Future value or Face value = $1,000

PMT = 1,000 × 6% ÷ 2 = $30

NPER = 12 years × 2 = 24 years

The formula is shown below:

= Rate(NPER;PMT;-PV;FV;type)

The present value come in negative

So, after solving this,

1. The pretax cost of debt is 4.89%

2. And, the after tax cost of debt would be

= Pretax cost of debt × ( 1 - tax rate)

= 4.89% × ( 1 - 0.35)

= 3.18%