Question

J&R Renovation, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 20 years to maturity that is quoted at 107 % of face value. The issue makes semi-annual payments and has a coupon rate of 9 % annually.
A. What is the company's pretax cost of debt?
B. If the tax rate is 35 %, what is the aftertax cost of debt?

Answer 1

Answer:

a) 8.36%

b) 5.43%

Explanation:

to find the pretax cost of debt we must find the yield to maturity:

YTM = {coupon + [(face value - market value) / n]} / [(face value + market value) / 2]

YTM = {45 + [(1,000 - 1,070) / 40]} / [(1,000 + 1,070) / 2] = 43.25 / 1,035 = 0.04178 x 2 = 0.08357 = 8.36%

after tax cost of debt = 8.36% x (1 - 35%) = 8.36% x 0.65 = 5.43%