Handy Man, Inc., has zero coupon bonds outstanding that mature in 4 years. The bonds have a face value of $1,000 and a current market price of $798. What is the pretax cost of debt? (Use semiannual compounding.)

Question

Quizplus · Accepted Answer

The formula to calculate the cost of debt is:

Cost of debt = (Face value - Current market price) / Face value * (2 / T)

Where T is the number of periods, in this case, 4 years, or 8 semi-annual periods.

Cost of debt = (1,000 - 798) / 1,000 * (2 / 8) = 0.0572 or 5.72%

Therefore, the pretax cost of debt is 5.72%. The closest option is C.