Question

ICU Windows, INC., is trying to determine its cost of debt. The firm has a debt issue outstanding with 8 years to maturity that is quoted at 103.5 percent of face value. The issue makes semiannual payments and has an embedded cost of 5.2 percent annually.

a.What is the company's pretax cost of debt?
b.If the tax rate is 21 percent, what is the aftertax cost of debt?

Answer 1

a. To calculate the company's pretax cost of debt, we need to use the embedded cost of debt. In this case, the embedded cost of debt is given as 5.2 percent annually. Since the debt issue makes semiannual payments, we need to divide the annual rate by 2 to get the semiannual rate.

Annual rate: 5.2%
Semiannual rate: 5.2% / 2 = 2.6%

Therefore, the company's pretax cost of debt is 2.6%.

b. To calculate the aftertax cost of debt, we need to consider the tax rate. In this case, the tax rate is given as 21 percent.

Aftertax cost of debt = Pretax cost of debt * (1 - Tax rate)

Aftertax cost of debt = 2.6% * (1 - 0.21) = 2.6% * 0.79

Therefore, the company's aftertax cost of debt is 2.054%.