Question

Spartans has 6.5 percent bonds outstanding that mature in 18 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $985 each. What is the firm's pretax cost of debt? Multiple Choice 6.77 percent 6.64 percent 6.94 percent 7.11 percent 6.20 percent

Answer 1

Cost of Debt is the Rate at which PV of cash inflows are equal to PV of Cash Outflows.

Period	CF	PVF @3%	Disc CF	PVF @3.5%	Disc CF
0	$ -985.00	1.0000	$ -985.00	1.0000	$ -985.00
1	$      32.50	0.9709	$    31.55	0.9662	$    31.40
2	$      32.50	0.9426	$    30.63	0.9335	$    30.34
3	$      32.50	0.9151	$    29.74	0.9019	$    29.31
4	$      32.50	0.8885	$    28.88	0.8714	$    28.32
5	$      32.50	0.8626	$    28.03	0.8420	$    27.36
6	$      32.50	0.8375	$    27.22	0.8135	$    26.44
7	$      32.50	0.8131	$    26.43	0.7860	$    25.54
8	$      32.50	0.7894	$    25.66	0.7594	$    24.68
9	$      32.50	0.7664	$    24.91	0.7337	$    23.85
10	$      32.50	0.7441	$    24.18	0.7089	$    23.04
11	$      32.50	0.7224	$    23.48	0.6849	$    22.26
12	$      32.50	0.7014	$    22.79	0.6618	$    21.51
13	$      32.50	0.6810	$    22.13	0.6394	$    20.78
14	$      32.50	0.6611	$    21.49	0.6178	$    20.08
15	$      32.50	0.6419	$    20.86	0.5969	$    19.40
16	$      32.50	0.6232	$    20.25	0.5767	$    18.74
17	$      32.50	0.6050	$    19.66	0.5572	$    18.11
18	$      32.50	0.5874	$    19.09	0.5384	$    17.50
19	$      32.50	0.5703	$    18.53	0.5202	$    16.91
20	$      32.50	0.5537	$    17.99	0.5026	$    16.33
21	$      32.50	0.5375	$    17.47	0.4856	$    15.78
22	$      32.50	0.5219	$    16.96	0.4692	$    15.25
23	$      32.50	0.5067	$    16.47	0.4533	$    14.73
24	$      32.50	0.4919	$    15.99	0.4380	$    14.23
25	$      32.50	0.4776	$    15.52	0.4231	$    13.75
26	$      32.50	0.4637	$    15.07	0.4088	$    13.29
27	$      32.50	0.4502	$    14.63	0.3950	$    12.84
28	$      32.50	0.4371	$    14.20	0.3817	$    12.40
29	$      32.50	0.4243	$    13.79	0.3687	$    11.98
30	$      32.50	0.4120	$    13.39	0.3563	$    11.58
31	$      32.50	0.4000	$    13.00	0.3442	$    11.19
32	$      32.50	0.3883	$    12.62	0.3326	$    10.81
33	$      32.50	0.3770	$    12.25	0.3213	$    10.44
34	$      32.50	0.3660	$    11.90	0.3105	$    10.09
35	$      32.50	0.3554	$    11.55	0.3000	$       9.75
36	$      32.50	0.3450	$    11.21	0.2898	$       9.42
36	$ 1,000.00	0.3450	$ 345.03	0.2898	$ 289.83
NPV			$    69.58		$   -35.73

Pre Tax cost of Debt per six Months = Rate at which least +ve NPV + [ NPV at that rate / Change in NPV due to 0.5% inc in disc Rate ] * 0.5%

= 3% + [ 69.58 / 105.31 ] * 0.5%

= 3% + [ 0.64 * 0.5% ]

= 3% + 0.32%

= 3.32%

Pre Tax cost of Debt per anum = 3.32% * 12 / 6

= 6.64%