Final answer:
To find Wasser, Inc.'s cost of debt, calculate the yield to maturity (YTM) for its bond issue based on semiannual payments, adjust for an annual rate, and then account for the tax deductibility of interest expenses by multiplying the annual YTM by (1 - tax rate).
Step-by-step explanation:
To calculate the cost of debt for Wasser, Inc., which has a bond issue outstanding with 12 years to maturity, quoted at 97 percent of face value, a coupon rate of 10 percent, and tax rate of 25 percent, we need to determine the yield to maturity (YTM) on a semiannual basis and then adjust for taxes. The bond makes semiannual payments, which means the annual coupon payment of 10 percent is divided into two. Therefore, each payment is 5 percent of the face value.
Using a financial calculator or a present value formula for bonds, input the current price (97 percent of face value), the coupon payment (5 percent of face value, since it is semiannual), the number of periods until maturity (which is 12 years times 2, because of semiannual payments), and the face value to solve for the YTM. The formula for present value of annuity is used to calculate the value of the remaining coupon payments, and the present value of a lump sum is used for the face value of the bond at maturity.
Once the semiannual YTM has been calculated, it must be doubled to get the annual YTM. However, since interest expenses are tax deductible, the tax rate must be accounted for. The after-tax cost of debt is then calculated by multiplying the YTM by (1 - tax rate). This will provide us with the effective after-tax cost of debt for Wasser, Inc.