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Suppose the risk-free rate is 3.5%; on average, an AAA-rated corporate bond carries a credit spread of 0.3%, an A-rated corporate bond carries a credit spread of 1.1%, and a B-rated corporate bond carries a credit spread of 3.9%. Company XYZ's outstanding debt is rated BBB by rating agencies. What would be the cost of debt for XYZ based on prevailing market rates? Multiple Choice

A .4%
B .5%
C .8%
D .6%

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Answer and Explanation:

The answer given in the question are not correct. Following should be the choices:

A: 6.5%

B: 7.4%

C: 3.8%

D: 4.6%

The correct answer is A. 6.5 %

The reason is:

3.5% x 1.1% = 4.6%

3.5% + 3.9% = 7.4%

It has to be in between this which is,

4.6% < 6.5% < 7.4%

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