Question

ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with seven years to maturity that is quoted at 110 percent of face value. The issue makes semiannual payments and has an embedded cost of 8.2 percent annually.

What is the company’s pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Pretax cost of debt             %

If the tax rate is 30 percent, what is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Aftertax cost of debt             %

Answer 1

Information provided:

Face value= future value= $1,000

Present value= 110*$1,000= $1,100

Time= 7 years*2= 14 semi-annual periods

Coupon rate= 8.2%/2= 4.1%

Coupon payment= 0.041*1,000= $41

1.The pretax cost of debt is calculated by computing the yield to maturity.

Enter the below in a financial calculator to compute the yield to maturity:

FV= 1,000

PV= -1,100

PMT= 41

N= 14

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 3.2025.

Therefore, the pretax cost of debt is 3.2025%*2= 6.4045% $\rightarrow$   6.40%.

2.After tax cost of debt= before tax cost of debt*(1 – tax rate)

                                    = 6.40%*(1 – 0.30)

                                    = 4.48%.

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