The approximate before-tax cost of debt for a 15-year, 10 percent, $1,000 par value bond selling at$950 is
A) 15.4 percent.
B) 10.6 percent.
C) 10 percent.
D) 12 percent.

Question

Quizplus · Accepted Answer

The before-tax cost of debt can be calculated using the following formula:

Before-tax cost of debt = (Coupon payment / Bond price) + ((Par value – Bond price) / Years to maturity) / 2

Coupon payment = Par value x Coupon rate
Coupon payment = $1,000 x 10% = $100

Before-tax cost of debt = ($100 / $950) + (($1,000 – $950) / 15) / 2
Before-tax cost of debt = 0.1053 or 10.53%

Rounding the answer to the nearest tenth gives us the answer of 10.6%. Therefore, the best choice is B.

The Approximate Before-Tax Cost of Debt for a 15-Year, 10