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31 October, 21:16

A new corporate bond is being offered for $930. The bond has a face value of $1,000 and matures in 10 years. The coupon rate is 7% per year, payable annually. What is the company's cost of capital for this bond issue if the bond broker's fee = $15 per bond?

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  1. 31 October, 22:09
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    The answer is 7.65%

    Explanation:

    The cost of capital is equal to the cost of debt in this example as it involves a debt instrument. The formula for the cost of debt is as follows:

    (Interest Expense x (1 - Tax Rate) : (Amount of Debt - Debt Acquisition Fees + Premium on Debt - Discount on Debt)

    In the example, the given values are the following:

    Interest Expense = 7% x $1,000 = $70 (no tax rate was provided)

    Amount of debt = $1,000 (face value of the bond)

    Debt acquisition fee = $15

    Discount on debt = $70 ($1,000 face value vs. the $930 proceeds of the bond, the bond was issued at a discount)

    Solution:

    $70 : ($1,000 - $15 - $70) = 7.65% cost of capital (cost of debt)
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