Kenny Electric Company's noncallable bonds were issued several years ago and now have 20 years to maturity. These bonds have a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000. If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation? a. 4.35%b. 4.58%c. 4.83%d. 5.08%e. 5.33%

Question

Molly Waters

Business

3 December, 10:04

Kenny Electric Company's noncallable bonds were issued several years ago and now have 20 years to maturity. These bonds have a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000. If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation? a. 4.35%b. 4.58%c. 4.83%d. 5.08%e. 5.33%

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Answers (1)

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Fletcher Shields · Answer 1

d. 5.08%.

Explanation

Give that Kenny Electric Company's noncallable bonds were issued several years ago and now have 20 years to maturity. These bonds have a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000 and that if the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation. To do this our first step is to calculate the yield to maturity (YTM) as follows:

46.25 * [1 - (1+YTM/2) ˆ-40]/YTM/2 + 1000 / (1+YTM/2) ˆ40 = 1075

Therefore, YTM = 8.46%. second step we need to calculate the cost of debt as follows. The cost of debt = 8.46% * (1-40%) = 5.08%. This means that the correct answer is d. 5.08%.