Mudvayne, Inc., is trying to determine its cost of debt. The firm has a debt iss

Question

Mudvayne, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 20 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has an embedded cost of 9 percent annually.

What is the company’s pretax cost of debt? (Do not round intermediate calculation and round your answer to 2 decimal places. (e.g., 32.16))

Cost of debt= %

If the tax rate is 35 percent, what is the aftertax cost of debt? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16))

Cost of debt= %

Explanation / Answer

Using the market value approach to cost of debt, we have

Pre-tax cost of debt = Annual coupon payment / Market price of stock = 9% x 100 / 107 = 8.41%

After-tax cost of debt = Pre-tax cost x (1 - Tax rate)

= 8.41% x (1 - 0.35) = 8.41% x 0.65 = 5.47%

Note: Results will slightly differ if YTM approach is used. But since question doesn't mention which method to follow, the Market Value method is used.

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