A firm has outstanding debt paying annual coupons,with a coupon rate of 10%,and 8 years to maturity.The firm's bonds are currently trading at a price of $875.50 per $1000 face value.What is the firm's cost of debt if it has a tax rate of 25%?

Question

Quizplus · Accepted Answer

First, calculate the annual coupon payment:

Annual coupon payment = 10% * $1000 = $100

Next, calculate the yield to maturity (YTM) using the bond price:

$875.50 = $100 / (1 + YTM)^1 + $100 / (1 + YTM)^2 + ... + $100 / (1 + YTM)^8 + $1000 / (1 + YTM)^8

Using financial calculator or excel function, the YTM is found to be 12%.

Finally, adjust the YTM for the tax rate:

Cost of debt = YTM * (1 - tax rate)

Cost of debt = 12% * (1 - 0.25) = 9.4%

Therefore, the answer is choice C (9.4%).

A Firm Has Outstanding Debt Paying Annual Coupons,with a Coupon