Macy Pharmacy\'s bonds have a 12 percent coupon, paid semiannually, a current ma

Question

Macy Pharmacy's bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. Macy Pharmacy's beta is 1.2, the risk-free rate is 10%, and the market risk premium is 5%. Macy is a constant-growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8%. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find the cost of equity. The firm's marginal tax rate is 40 percent. What is the component cost of debt?

Explanation / Answer

Face value (FV) $                                  1,000.00 Coupon rate 12.00% Number of compounding periods per year 2 Interest per period (PMT)                                            60.00 Bond price (PV) $                               (1,000.00) Number of years to maturity 20 Number of compounding periods till maturity (N) 40 Bond Yield to maturity RATE(NPER,PMT,PV,FV)*2 Bond Yield to maturity 12.00% (Pre-tax cost of debt) Bond Yield to maturity 7.20% (Component cost of debt) 12%*(1-40%)

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