A firm recently issued $1,000 par value, 20-year bonds with a coupon rate of 6% and semi-annual payments. The bonds sold at par value, but flotation costs amounted to 5% of par value. The firm has a marginal tax rate of 21%. What is the firm's cost of debt for these bonds?

a) 5.09%

b) 6.00%

c) 4.74%

d) 9.48%

e) 6.45%

e) 6.45%

Explanation:

Since the coupons are paid semiannually, adjust the coupon payment (PMT), the time (N) of the bond.

You can solve for cost of debt using financial calculator with the following inputs;

Maturity of the bond; N = 20 * 2 = 40

Face value; FV = 1000

Coupon payment; PMT = (6%/2) * 1000 = 30

Price; PV = - (1000 - floatation cost) = - (1000 - (5%*1000) = - 950

then compute semiannual interest rate; CPT I/Y = 3.224%

Convert semiannual interest rate to annual rate to find the cost of debt;

3.224% * 2 = 6.45%