What is ICU’s pretax cost of debt?
What is ICU’s pretax cost of debt?
ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with eight years to maturity that is quoted at 110.5 percent of face value. The issue makes semiannual payments and has an embedded cost of 8.4 percent annually.
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To calculate ICU's pretax cost of debt, we need to use the information provided. Here's how you can calculate it:
1. Determine the market price of the debt issue:
The debt issue is quoted at 110.5 percent of face value. Face value refers to the value of the debt at maturity. To find the market price, multiply the face value by 110.5%:
Market price = Face value * 110.5% = Face value * 1.105
2. Calculate the interest payment:
The debt issue makes semiannual payments, which means there are two payments per year. The embedded cost of the debt is given as 8.4% per year. To find the semiannual interest payment, divide the annual interest rate by 2:
Semiannual interest payment = Annual interest rate / 2
3. Determine the number of periods:
The debt issue has eight years to maturity. Since there are two payments per year, multiply the number of years by 2:
Number of periods = Number of years * 2
4. Calculate the pretax cost of debt using the formula for the present value of a bond:
Pretax cost of debt = (Annual interest payment / Market price) * 100%
Now, let's plug in the values and calculate ICU's pretax cost of debt:
Market price = Face value * 1.105
Semiannual interest payment = 8.4% / 2
Number of periods = 8 years * 2
Pretax cost of debt = (Semiannual interest payment / Market price) * 100%
Substitute the values into the formula and calculate the result.