Problem 12-6 Calculating Cost of Debt [LO 2] ICU Window, Inc., is trying to dete
ID: 2761822 • Letter: P
Question
Problem 12-6 Calculating Cost of Debt [LO 2] 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 112 percent of face value. The issue makes semiannual payments and has an embedded cost of 9 percent annually. Requirement 1: 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).) Pretax cost of debt % Requirement 2: If the tax rate is 34 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).) Aftertax cost of debt %
Explanation / Answer
Number of periods, N = 2 * 7 = 14
Present Value, PV = 112% of $1,000 = $1,120
Periodic payment, PMT = (9% of $1,000)/2 = $45
Future Value, FV = $1,000
Now, Calculate cost of debt, Using financial calculator, Enter, N = 14, PV = -1120, PMT = 45, FV = 1000 and press I/Yr key, rate will be 3.41%
Since, it is a semi-annual bond, so, ICU’s pretax cost of debt, rd is 6.82% i.e. (2 * 3.41%)
2. After tax cost of debt = Before tax cost of debt (1- tax rate)
= 6.82% (1-0.34) = 4.50%