The week 2 finance lab in FIN 370 presents a huge challenge to many students. Going from very little finance knowledge to solving complex cost of capital problems is a lot to ask an online student. Fortunately, these problems can be solved much easier if you take them step-by-step. Let’s break the process down for each step.
“A bond that has a $ 1,000 par value (face value) and a contract or coupon interest rate of 10.5%. The bonds have a current market value of$ 1,124 and will mature in 10 years. The firm's marginal tax rate is 34%.” What is the cost of debt?
Step 1 – The Cost of Capital Formula
It really helps if you have a solid understanding of bonds when you solve this problem. The basic formula can be expressed like this:
Cost of Capital = Yield to maturity (YTM) * (1-Marginal Tax Rate)
Step 2 – Finding the Yield to Maturity YTM
We can find the YTM by using the following formula:
YTM = (Annual interest+ (Par-Price of Bond )/Number of years until bond maturity )/(Bond par value + market price)/2
You can check your work using a YTM calculator. We really like this YTM calculator provided by Investopedia. Its best to work out the formula first, then check your work using the calculator.
Step 3 – Solve It
Use the order of operations to solve the equation. It helps to have a good finance or graphing calculator, but that is not completely necessary.
Cost of Debt = 0.0860*(1-0.34)= 0.0567 or 5.67%
Cost of Debt = 5.67%
That’s it, you’ve solved it in 3 easy steps.
FIN 370 Answer Presentation for Week 2
Sometimes it is easier to under standing the process of solving financial problems with a visual aid. Below you will find a presentation that will walk you through the process visually.
Maybe a Video will Help?
These concepts take a lot of practice to master. Here is a quick video that will provide even more tips to help you get a grip on week 2 finance lab solutions.
Want additional tutoring on FIN 370 Labs?
We’ve got you covered, check out the FIN 370 collection to get all the answers you need for the 2014 academic year.