Question

Jiminy’s Cricket Farm issued a bond with 16 years to maturity and a semiannual coupon rate of 6 percent 2 years ago. The bond currently sells for 91 percent of its face value. The company’s tax rate is 35 percent. a. What is the pretax cost of debt? (Do not round intermediate calculations. 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. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

Pretax cost of debt = 7.02%

Aftertax cost of debt is 4.56%

Explanation:

As of today, the time to maturity of this bond is 16-2 = 14 years.

You can solve the pretax cost of debt; YTM using the following inputs in a financial calculator;

Time to maturity; N  = 14*2 = 28

Face value; FV = 1000

Semiannual coupon payment ; PMT = (6%/2) *1000 = 30

Price of the bond ; PV = 0.91* 1000 = 910

Compute the semiannual interest rate ; CPT I/Y = 3.510%

Since YTM is an annual rat; multiply 3.510% by 2

Pretax cost of debt = 7.02%

b.) Aftertax cost of debt = pretax cost of debt * (1-tax)

= 7.02% *(1-0.35)

= 4.563%

Therefore, aftertax cost of debt is 4.56%