Question

DeAndre Hunter Enterprises has found that its common equity capital shares have a beta equal to 1.5 while the risk-free return is 8 percent and the expected return on the market is 14 percent. The firm is financed with $120,000,000 of common shares (market value) and $80,000,000 of debt, and 35 percent is the marginal tax rate.

The firm has semiannual bonds outstanding with nine years to maturity and are currently priced at $754.08. The bonds have a coupon rate of 7.25 percent. The face value on a bond is $1,000. The firm will invest $300,000 in a five-year project today that will produce annual cash flows of $80,000.

What is the cost of debt for the firm?(Calculate as a Yield to maturity)

Answer 1

What is the cost of debt for the firm? (What is the Yield to Maturity (YTM)? )

Answer: 5.60%

Working

Formula for calculating Yield To Maturity (YTM)

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F (i.e. Face value) = $1000

P (i.e. current price) = $754.08

N = period = 18 (9 year * 2 (i.e. semiannual coupon payment))

C (i.e. coupon)          = Face value * Coupon Rate

                                    = $1000 * 3.625%

                                    = $36.25

(Note: since coupons are paid semiannually so coupon rate will be 3.625% (i.e. 7.25% ÷2)

Yield To Maturity (YTM) Calculation

                        = 49.9122 / 877.04

                                    =.05600

                                    =5.60 %

Note: Above calculated cost of debt is pretax cost of debt.