Asked by Emily Calabrese on Jun 18, 2024
Verified
Wilson's Cabinets has bonds outstanding that mature in eight years, have a 6 % coupon and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,020. What is the company's pre-tax cost of debt?
A) 5.68 %
B) 6.19 %
C) 6.34 %
D) 6.82 %
E) 7.57 %
Pre-tax Cost
The expense associated with an investment or action before the effects of taxes are taken into account.
Pay Interest
The act of compensating a lender for the use of borrowed money, usually determined as a percentage of the principal loan amount.
Market Price
The rate in the market at which an asset or service can be bought or sold today.
- Ascertain the pre-tax expenditure on debt.
Verified Answer
DP
Diana PlangJun 25, 2024
Final Answer :
A
Explanation :
The pre-tax cost of debt can be calculated using the yield to maturity (YTM) formula, which takes into account the annual coupon payments, the face value, the current market price, and the time to maturity. Given the bond's annual coupon of $60 (6% of $1000), a current price of $1020, a face value of $1000, and 8 years to maturity, the YTM calculation will yield a pre-tax cost of debt of approximately 5.68%. This calculation involves solving for the discount rate that equates the present value of all future cash flows (coupon payments and the repayment of the principal at maturity) to the bond's current price.
Learning Objectives
- Ascertain the pre-tax expenditure on debt.