Answer:
pretax cost of debt: 6.633%
Explanation:
We have to solve for the interest rate at which the present value of the coupon payment and maturity matches the present value of the bonds.
This is done using excelor a financial calculation
Present value of the coupon payment (ordinary annuity)
[tex]C \times \frac{1-(1+r)^{-time} }{rate} = PV\\[/tex]
C 35 (1,000 x 7% / 2 payment per year)
time 24 ( 12 years x 2 payment per year)
rate 0.033167588
[tex]35 \times \frac{1-(1+0.033167588)^{-24} }{0.033167588} = PV\\[/tex]
PV $573.0155
Present value of maturity (lump sum)
[tex]\frac{Maturity}{(1 + rate)^{time} } = PV[/tex]
Maturity 1,000.00
time 24.00
rate 0.033167588
[tex]\frac{1000}{(1 + 0.033167588)^{24} } = PV[/tex]
PV 456.98
PV c $573.0155
PV m $456.9845
Total $1,030.0000
Notice this rate is given with semianual payment we should multiply by two to get the annual cost of debt:
0.033167588 x 2 = 0.06633
