Question

ICU Window, inc, is trying to determine its cost od debt. The firm has a debt issue outstanding with seven years to maturity that is quoted at 108 percent of face value. The issue makes semiannual payments and has an embedded cost of 6.1 percent annually. What is ICU's pretax cost of debt? If the tax rate is 38 percent, what is the aftertax cost of debt?

Answer 1

The pretax cost of debt is 9.86% and the aftertax cost of debt is 6.10%.

Step-by-step explanation:

The cost of debt is the total interest expense owed on a debt. Put simply, the cost of debt is the effective interest rate or the total amount of interest that a company or individual owes on any liabilities, such as bonds and loans. This expense can refer to either the before-tax or after-tax cost of debt.

The pretax cost of debt can be calculated using the formula:

Pretax Cost of Debt = Embedded Cost of Debt / (1 - Tax Rate)

In this case, the embedded cost of debt is 6.1% annually. The tax rate is 38%.

So, the pretax cost of debt will be:

Pretax Cost of Debt = 6.1% / (1 - 38%) = 9.86%.

The aftertax cost of debt can be calculated by subtracting the tax savings from the pretax cost of debt. In this case, the tax savings is 38% of the pretax cost of debt.

So, the aftertax cost of debt will be:

Aftertax Cost of Debt = Pretax Cost of Debt - Tax Savings

Aftertax Cost of Debt = 9.86% - (38% x 9.86%) = 6.10%.