The outstanding debt of Billabong has five years to maturity, a current yield of 6%, and a price of $95. What is the pre-tax cost of debt if the tax rate is 30%?

Question

Quizplus · Accepted Answer

The pre-tax cost of debt can be calculated as the current yield divided by (1 - tax rate).
Current yield = 6%
Tax rate = 30%
Price = $95

Therefore, pre-tax cost of debt = 6%/(1-0.30) = 8.57%
Alternatively, we can use the yield to maturity (YTM) formula, which is:
YTM = (annual interest payment + (face value - market price) / years to maturity) / ((face value + market price) / 2)
Annual interest payment can be calculated as current yield x face value = 6% x $100 = $6
Using the values given in the question, we get:
YTM = ($6 + ($100-$95)/5) / (($100+$95)/2) = 8.57%
Hence, the pre-tax cost of debt is 8.57%. Therefore, the best choice is C.

The Outstanding Debt of Billabong Has Five Years to Maturity