ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt i
ID: 1171281 • Letter: I
Question
ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with seven years to maturity that is quoted at 108 percent of face value. The issue makes semiannual payments and has an embedded cost of 6.1 percent annually.
What is ICU’s pretax cost of debt? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
If the tax rate is 38 percent, what is the aftertax cost of debt? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with seven years to maturity that is quoted at 108 percent of face value. The issue makes semiannual payments and has an embedded cost of 6.1 percent annually.
Explanation / Answer
Requirement 1:
ICU’s pretax cost of debt = 4.74%
Requirement 2:
ICU’s after-tax cost of debt = 4.74% x [ 1 -0.38 ] = 2.94%
Workings
Yield To Maturity [YTM]
YTM = Coupon Amount + [ (Par Value – Bond Price) / Maturity Years ] / [(Par Value + Bond Price)/2]
= $61 + [ ($1,000 – 1,080) / 7 Years ) ] / [($1,000 + 1,080) / 2 ]
= [ ($61 – 11.43) / 1,040 ] x 100
= 4.74%