Drogo, Inc., is trying to determine its cost of debt. The firm has a debt issue

Question

Drogo, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 16 years to maturity that is quoted at 106 percent of face value. The issue makes semiannual payments and has an embedded cost of 6 percent annually. What is the company's pretax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) answer as a percent rounded to 2 decimal places, e.g., 32.16) Pretax cost of debt If the tax rate is 35 percent, what is the aftertax cost of debt? (Do not round intermediate calculations Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Enter your answer as a percent rounded to 2 decimal places, e.g, 32.16.) Aftertax cost of debt

Explanation / Answer

1-cost of debt = interest + (redemption value- market value)/ years to maturity / redemption value+ market value)/2

6 + (100-106)/16 / (100+102)/2 = 5.569%

after tax cost of debt = 5.569%*(1-.35) = 3.62%

2- cost of debt = interest + (redemption value- market value)/ years to maturity / redemption value+ market value)/2

10 + (100-96)/26 / (100+96)/2 = 10.36%

After tax cost of debt = 10.36%*(1-.35)= 6.73%

after tax cost od debt is more important because it is the real cost of fund raised.

3-

ratio of debt and equity weight cost of source Weight * cost of source debt 1.35 0.5744681 4.077778 2.34255319 equity 1 0.4255319 14 5.95744681 2.35 overall cost 8.3 cost of debt is 4.08% cost of equity ratio of debt and equity weight cost of source Weight * cost of source debt 1.35 0.5744681 3.8 2.18297872 equity 1 0.4255319 14.375 6.11702128 2.35 overall cost 8.3 cost of equity is 14.375% 14.38% answer no 4 no of unit outstanding market price per unit market value Equity 9600000 44 422400000 preferred stock 400000 94 37600000 debt 210000 115 24150000 Market value of capital structure 484150000 cost of equity IRF + (Rm- IRF)*beta 9.72 percent cost of preferred stock (preference dividend/market price )*100 6.382979 percent cost of debt interest +(Redemption value-market value/ years to maturity / Redemption value+market value/2 78.25 1057.5 7.399527 4.43971631 after tax cost of debt answer no 4 no of unit outstanding market price per unit market value Weights rate Equity 9600000 44 422400000 0.872457 9.72 8.480281 preferred stock 400000 94 37600000 0.077662 6.38297872 0.495714 debt 210000 115 24150000 0.049881 4.43971631 0.221459 Market value of capital structure 484150000 weighted average cost of capital 9.197454

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