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Advance, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 16 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has a coupon rate of 10 percent. What is the company's pretax cost of debt?

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Answer:

R= 9.16%

Explanation:

Step 1. Given information.

  • Let Pretax cost of debt= r
  • Coupon rate 10%

Step 2. Formulas needed to solve the exercise.

The present value of r is considered taking into account the period of time of the exercise. In this case the period n=32 is because the amount is paid twice in a year, thus, n=16*2

Step 3. Calculation and Step 4. Solution.

Coupon = 10%*1000/2= 50

107%*1000 = 50*(1-1/(1+r/2)^32)/(r/2)+ 1000/(1+r/2)^32

R= 9.16%

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