Question

Viserion, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 24 years to maturity that is quoted at 92 percent of face value. The issue makes semiannual payments and has an embedded cost of 4 percent annually.

a. What is the company’s pretax cost of debt? b. If the tax rate is 23 percent, what is the aftertax cost of debt?

Answer 1

A) 4.51%

B) 3.47%

Step-by-step explanation:

The pretax cost of debt will be the yield to maturity of the bonds.

YTM = {C + [(F - P)/n]} / [(F + P)/2]

• C = 4%/2 = 2% ⇒ 20
• F = 1,000
• P = 920
• n = 24 years x 2 = 48

YTM = {20 + [(1000 - 920)/48]} / [(1000 + 920)/2]

YTM = 21.67 / 960 = 2.257% x 2 = 4.51% annual

pretax cost of debt = 4.51%

after tax cost of debt = pretax cost x (1 - tax rate) = 4.51% x (1 - 23%) = 3.47%