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

pretax cost of debt: 6.633%

Step-by-step 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 * (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 * (1-(1+0.033167588)^(-24) )/(0.033167588) = PV\\`

PV $573.0155

Present value of maturity (lump sum)

`(Maturity)/((1 + rate)^(time) ) = PV`

Maturity 1,000.00

time 24.00

rate 0.033167588

`(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