Question

Jiminy's Cricket Farm issued a bond with 15 years to maturity and a semiannual coupon rate of 5 percent 3 years ago. The bond currently sells for 92 percent of its face value. The company's tax rate is 22 percent. A. What is the pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.G., 32.16.) b. What is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.G., 32.16.)

Answer 1

Answer:

Pretax cost of debt is 5.94%

After tax cost of debt is 4.63%

Step-by-step explanation:

The pretax cost of the debt is the yield to maturity on the debt issuance,which can be computed using the rate formula in excel:

=rate(nper,pmt,-pv,fv)

nper  is the number of semi-annual interest payments payable by the bond from year 3 onward ,that is the number of years to maturity 12*2=24

pmt is the semi-annual interest payable by the bond issuer which is face value of the bond ,$1000*5%/2=$25

pv is the current  price of the bond which 92% of face value i.e 92%*$1000=$920

fv is the face value of the bond at $1000

=rate(24,25,-920,1000)

rate=2.97%

the rate calculated is a semi-annual rate,annual rate =2.97%*2

                                                                                        =5.94%

The pretax cost of debt is  5.94%

After tax cost of debt=pretax cost of debt*(1-t)

t is the tax rate of 22%

after tax cost  of debt =5.94%*(1-22%)

                                    =4.63%