Jiminy’s Cricket Farm issued a bond with 18 years to maturity and a semiannual c

Question

Jiminy’s Cricket Farm issued a bond with 18 years to maturity and a semiannual coupon rate of 8 percent 3 years ago. The bond currently sells for 92 percent of its face value. The company’s tax rate is 35 percent.

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.)

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.)

Which is more relevant, the pretax or the aftertax cost of debt?

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.)

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.)

Which is more relevant, the pretax or the aftertax cost of debt?

Explanation / Answer

P0 = $ 920

Coupon = 40 (1,000*8%*0.5)

T=(18-3)*2

R = 4.075%

YTM = 2 × 4.075% = 8.15%

b. The aftertax cost of debt is:

• RD = .0815(1 – .35) = .0529 or 5.29%

• c. The after-tax rate is more relevant because that is the actual cost to the company.

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