Question

Calculating Cost of Debt

One Step, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 17 years to maturity that is quoted at 95 percent of face value. The issue makes semiannual payments and has a coupon rate of 6 percent. What is the company’s pretax cost of debt? If the tax rate is 21 percent, what is the after tax cost of debt?

Answer 1

To find the pre-tax cost of debt, we need to put the following values in the financial calculator:

N = 17*2 = 34;

PV = -95%*1000 = -950;

PMT = (6%/2)*1000 = 30;

FV = 1000;

Press CPT, then I/Y, which gives us 3.24

So, Periodic Rate = 3.24%

Pre-tax cost of debt = Periodic Rate * No. of compounding periods in a year = 3.24% * 2 = 6.49%

After-tax cost of debt = Pre-tax cost of debt * (1 - t) = 6.49% * (1 - 0.21) = 5.13%