Viserion, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 27 years to maturity that is quoted at 92 percent of face value. The issue makes semiannual payments and has an embedded cost of 7 percent annually.

Viserion, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 27 years to maturity that is quoted at 92 percent of face value. The issue makes semiannual payments and has an embedded cost of 7 percent annually.
a.   
What is the company’s pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

b.    If the tax rate is 25 percent, what is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation:

The pretax cost of debt is the YTM of the company’s bonds, so:

P0 = $920 = $35(PVIFAR%,54) + $1,000(PVIFR%,54)

R = 3.854%

YTM = 2 × 3.854% = 7.71%

And the aftertax cost of debt is:

RD = .0771(1 – .25)

RD = .0578, or 5.78%

Targaryen Corporation has a target capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt.

Targaryen Corporation has a target capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. Its cost of equity is 12 percent, the cost of preferred stock is 8 percent, and the pretax cost of debt is 9 percent. The relevant tax rate is 24 percent.

a.	What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b.	What is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation:

a.

Using the equation to calculate the WACC, we find:

WACC = .60(.12) + .05(.08) + .35(.09)(1 – .24)

WACC = .0999, or 9.99%

b.

The aftertax cost of debt is:

RD = .09(1 – .24)

RD = .0684, or 6.84%

Hence, on an aftertax basis, debt is cheaper than the preferred stock.