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XYZ bonds sell for $900. They have a $1,000 par value, 8% coupon

rate with semiannual coupons, and 18 years to maturity. What is the
pre-tax cost of debt?

User Xenonite
by
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1 Answer

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Final answer:

The pre-tax cost of debt cannot be determined without the tax rate information.

Step-by-step explanation:

In this case, the coupon rate is 8% and there is no information provided about the tax rate. Therefore, without the tax rate, it is not possible to determine the pre-tax cost of debt. The value of the bond at $900 and its par value of $1,000 can provide insights into the investor's perception of the bond's risk and expected return.

Annual coupon payment = Coupon rate * Par value

Annual coupon payment = 8% * $1,000 = $80

Since the bond pays semiannual coupons, the semiannual coupon payment will be half of the annual coupon payment:

Semiannual coupon payment = Annual coupon payment / 2

Semiannual coupon payment = $80 / 2 = $40

Next, we can calculate the number of coupon payments remaining until maturity. Since the bond has 18 years to maturity and pays semiannual coupons, there will be 18 * 2 = 36 coupon payments.

Now, let's calculate the YTM using the bond price, coupon payments, and years to maturity. We'll use an approximate method to find the YTM.

Using a financial calculator or spreadsheet software, we can input the following values:

N = 36

PMT = $40

FV = $1,000

PV = -$900

By solving for the interest rate (YTM), we find that the approximate YTM is approximately 4.82%.

Therefore, the pre-tax cost of debt for the XYZ bonds is approximately 4.82%.

User KRH
by
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