Question

Mudvayne, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 18 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has an embedded cost of 6 percent annually.

1. What is the companys pretax cost of debt?
2. If the tax rate is 35 percent, what is the aftertax cost of debt?

Answer 1

A. 5.42%

B. 3.52%

Step-by-step explanation:

A. Calculation for the companys pretax cost of debt

Using this formula

Pretax cost of debt= [Coupon payment +(Face value - price/Number of years)]/[(Face value - price)/2]

Let plug in the formula

Pretax cost of debt = (6%+((100%-107%)/18 years))/((100%+107%)/2)

Pretax cost of debt = 5.42%

Therefore the Pretax cost of debt will be 5.42%

B. Calculation for the aftertax cost of debt

After tax cost of debt = 5.42%*(1-35%)

After tax cost of debt = 5.42%*65%

After tax cost of debt = 3.52%

Therefore the After tax cost of debt will be 3.52%