Example 152

The Cost of Debt

Suppose the General Tool Company issued a 30-year, 7 percent bond 8 years ago. The bond is currently selling for 96 percent of its face value, or $960. What is General Tool's cost of debt?

Going back to Chapter 7, we need to calculate the yield to maturity on this bond. Because the bond is selling at a discount, the yield is apparently greater than 7 percent, but not much greater because the discount is fairly small. You can check to see that the yield to maturity is about 7.37 percent, assuming annual coupons. General Tool's cost of debt, RD, is thus 7.37 percent.

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