The outstanding debt of Billabong has ten years to maturity, a current yield of 7%, and a price of $95. What is the pretax cost of debt if the tax rate is 30%?

Question

Quizplus · Accepted Answer

Using the formula for after-tax cost of debt = pretax cost of debt * (1 - tax rate), we have:

Current yield = annual interest payment / bond price
0.07 = annual interest payment / $95
Annual interest payment = $6.65

Therefore, the pretax cost of debt can be calculated using the formula for yield to maturity:

$95 = $6.65 / (1 + r)^1 + $6.65 / (1 + r)^2 + ... + $6.65 / (1 + r)^10
Solving for r using a financial calculator or spreadsheet function, we get r = 7.37%.

Finally, the after-tax cost of debt is:

After-tax cost of debt = 7.37% * (1 - 0.30) = 5.16%

Therefore, the best choice is D, which represents the calculated after-tax cost of debt.

The Outstanding Debt of Billabong Has Ten Years to Maturity