P14-6 Calculating Cost of Debt [LO2] Waller, Inc., is trying to determine its co
ID: 2812450 • Letter: P
Question
P14-6 Calculating Cost of Debt [LO2] Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 12 years to maturity th embedded cost of 11 percent annually. at is quoted at 110 percent of face value. The issue makes semiannual payments and has an Required: (a) What is the company's pretax cost of debt? (Do not round your intermediate calculations.) (Click to select) (b)If the tax rate is 35 percent, what is the aftertax cost of deb!? (Do not round your intermediate calculations.) (Click to select) References eBook& Resources Worksheet Difficulty: BasicExplanation / Answer
(a) Computation of the company's pre-tax cost of debt.We have,
Face Value of debt(Assume) = $ 1,000
Current value of debt = 110 % of face value = 1,000 x 110% = $ 1,100
Number of year(n) = 12 years
Embedded cost of debt = 11 % annually
Step1: Compuation of the Interest expenses.We have,
Embedded cost of debt = Total Annual Interest Expense / Average Outstanding Debt
Total annual interest expenses = Average outstanding debt x Embedded cost of debt
Total annual interest expenses = (1,000 + 1,100)/ 2 x 11 %
Total annual interest expenses = $ 115.50
Step2: Computation of the pre-tax cost of debt.We have,
Pre-tax cost of debt = [Interest + ( Face value - Current price) / n] / ( Face value + Current price)/2
Pre-tax cost of debt = [ 115.50 + ( 1,000 - 1,100)/12] / ( 1,000 + 1,100)/2
Pre-tax cost of debt = [ 115.50 - 8.33] / 1,050 = 107.17 / 1,050 = 0.1021*100 = 10.21 %
(b) Computation of the after-tax cost of debt.We have,
After tax cost of debt = Pre-tax cost of debt (1- t)
Where,
t = tax rate = 35%
After tax cost of debt = 10.21%(1 - 0.35) = 6.64 %
Pre-tax cost of debt 10.21 %Related Questions
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