This is a simple problem but I'm not sure about one aspect of it.

A company has 15 year bonds outstanding, with a 5% annual coupon, a face value of \$1000, and a current market value of \$1100. What is the company's pre-tax cost of debt?

I'm tempted to think it's just 5%, as when the company originally sold the bonds it received $1000 and is paying 5% coupons on that original face value, but the inclusion of the current market value is confusing me. I'd appreciate any help you can give me.

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    $\begingroup$ Wild guess: CFA Level I question? $\endgroup$ – SRKX Dec 12 '12 at 23:19
  • $\begingroup$ @SRKX Exactly what ran through my head when I read it - that's why I included the accounting bit. $\endgroup$ – jeff m Dec 13 '12 at 4:12

It's a simple TVM problem - solve for the interest rate. The "current" cost of debt would be market determined, so that's why you use the market value. It ties into how bond accounting works - the premium of the bond is amortized until maturity. The amortization amount would be the difference between the coupon and the interest expense(market rate at issuance)

  • $\begingroup$ So I'm just calculating the YTM? $\endgroup$ – Cooper Royce Dec 7 '12 at 20:33
  • $\begingroup$ @CooperRoyce Unless I misunderstood the question, yes. $\endgroup$ – jeff m Dec 8 '12 at 21:41

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