American Dental Laser is selling a 10-year $1,000 face value bond with an 8% coupon rate. Interest is paid annually. The price to the public is $820, and the issue costs per bond are $10 each. Compute the pretax cost of debt for these bonds.

Question

Quizplus · Accepted Answer

First, we need to calculate the annual interest payment:

Annual interest payment = Face value * Coupon rate = $1,000 * 8% = $80

Next, we need to calculate the annual yield to maturity (YTM) of the bond:

Price = Present value of annual interest payments + Present value of face value

$820 = ($80 / (1 + YTM)^1) + ($1,000 / (1 + YTM)^10)

Using trial and error or a financial calculator, we can solve for YTM = 11.28%

Finally, we need to adjust the YTM for the issue costs:

Pretax cost of debt = YTM * (1 - Issue costs) = 11.28% * (1 - 0.01) = 11.3%

Therefore, the answer is B.

American Dental Laser Is Selling a 10-Year $1,000 Face Value