(Individual or component costs of capital)Your firm is considring a new investme
ID: 2692375 • Letter: #
Question
(Individual or component costs of capital)Your firm is considring a new investment proposal and would like to calculate its weighted average cost of capital.To help in this,compute the cost of capital for the firm for the following:
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A)A bond that has a $1,000 par value (face value) and a contract or coupon interest rate of 11.3%.The bods have a current market value of $1,120 and will mature in 10 years.The firm's marginal tax rate is 34%.
The cosr of capital from this bond debt is ___% (round to two decimal places.)
Explanation / Answer
The net interest paid is (1-0.34)*.113*1000 = $74.58
The price of the bond is the discounted value of the payments at the cost of debt.
1120 = 74.58{(1+i)-1 + (1+i)-2 + ... + (1+i)-10} + 1000(1+i)-10 ,where i = cost of debt.
When i = 0.05 , LHS = 1189.8
When i = 0.06, LHS = 1107.3
Thus, applying interpolation, we get i = 0.0584
Thus, cost of debt is 5.84%
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