Jiminy\'s Cricket Farm issued a 30-year, 6 percent semiannual bond 4 years ago.

Question

Jiminy's Cricket Farm issued a 30-year, 6 percent semiannual bond 4 years ago. The bond currently sells for 95 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 calculation and round your answer to 2 decimal places.
Cost of debt = ____%
b. What is the aftertax cost of debt? (Do not round intermediate calculations and round your answer to 2 decimal places.
Cost of debt = _____ %
c. Which is more relevant, the pretax or the aftertax cost of debt?

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part A:

Nper = (30 - 4)*2 = 52 (indicates the period over which interest payments are made)

PMT = 1000*6%*1/2 = 30 (indicates the amount of interest payment)

PV = 1000*95% =950 (indicates the present value of bonds)

FV = 1000 (indicates the face value of bonds)

Rate = ? (indicates the cost of debt)

Pre Tax Cost of Debt = Rate(Nper,PMT,PV,FV)*2 = RATE(52,30,-950,1000)*2 = 6.40%

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Part B:

After Tax Cost of Debt = Pre Tax Cost of Debt*(1-Tax Rate) = 6.40*(1-35%) = 4.16%

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Part C:

After Tax Cost of Debt is more relevant for any organization.

Thanks.

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