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3 March, 15:20

Viserion, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 24 years to maturity that is quoted at 92 percent of face value. The issue makes semiannual payments and has an embedded cost of 4 percent annually.

a. What is the company's pretax cost of debt? b. If the tax rate is 23 percent, what is the aftertax cost of debt?

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  1. 3 March, 19:04
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    A) 4.51%

    B) 3.47%

    Explanation:

    The pretax cost of debt will be the yield to maturity of the bonds.

    YTM = {C + [ (F - P) / n]} / [ (F + P) / 2]

    C = 4%/2 = 2% ⇒ 20 F = 1,000 P = 920 n = 24 years x 2 = 48

    YTM = {20 + [ (1000 - 920) / 48]} / [ (1000 + 920) / 2]

    YTM = 21.67 / 960 = 2.257% x 2 = 4.51% annual

    pretax cost of debt = 4.51%

    after tax cost of debt = pretax cost x (1 - tax rate) = 4.51% x (1 - 23%) = 3.47%
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