J&R Renovation, Inc., is trying to determine its cost of debt. The firm has a de

Question

J&R Renovation, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 10 years to maturity that is quoted at 110 percent of face value. The issue makes semiannual payments and has a coupon rate of 8 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             %

Explanation / Answer

Assuming the face value of the bond = $1000
Cost of debt = Yield to maturity of the bond.
Yield to maturity = Coupon payments + [Face value - Market price]/Number of periods / Average price *100
Coupon payments = $1000*8% = $80
Market price = $1000*110% = $1100
Yield to maturity = $80 + [$1000 - $1100]/10 / 1000+1100/2
= $80 - 10 / $1050 *100
= 6.67%
Pretax cost of debt= 6.67%
After tax cost of debt = Pretax cost *(1-Tax rate)
= 6.67*(1-0.35)
= 4.34%

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