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 105 percent of face value. The issue makes semiannual payments and has an embedded cost of 10 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.)

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.)

Aftertax cost of debt %

THE ANSWER IS NOT 10% Pretax NOR 6.50% AFTERTAX

Explanation / Answer

K =Nx2         
BOND PRICE= [(Semi-annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^(Nx2)
                   k=1

                    K= 16x2          
1050               = [(10*1000/(100*2))/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^16x2
                   k=1

YTM(Pretax cost of debt) = 9.39%

After tax cost of debt = YTM*(1-tax rate) = 9.39*(1-0.35) = 6.1%

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