Question

Suppose a corporation issued a 20-year annual, 7 percent bond, 10 years ago. The bond is currently selling for 92 percent of its face value, or $920. What is the corporation’s cost of debt?

Answer 1

Answer:

Cost of debt = 8.13 %

Explanation:

The cost of the debt would be equal to the yield on the bond.

The Yield to maturity is the discount rate that equates then price of the bonds to the present of cash inflows expected from the bond  

The yield on the bond can be determined as follows using the formula below:  

YTM = C + F-P/n) ÷ 1/2 (F+P)  

YTM-Yield to maturity-  

C- annual coupon  

F- Face Value  

P- Current Price  

n- years to maturity  

YTM-?, C- 7%× 1000 =70, Face Value - 1,000, P-920, n- 10

YTM = (70 + (1000-920)/10) ÷ ( 1/2× (1000 + 920) )  

YTM = 0.08125  × 100 = 8.13 %  

Yield to Maturity =8.13 %

Cost of debt = 8.13 %