Jiminy\'s Cricket Farm issued a 30-year, 10.8 percent semiannual bond 5 years ag

Question

Jiminy's Cricket Farm issued a 30-year, 10.8 percent semiannual bond 5 years ago. The bond currently sells for 84.5 percent of its face value. The company’s tax rate is 40 percent.

What is the pretax cost of debt? (Do not round intermediate calculations. Enter your answer as a percentage 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 percentage rounded to 2 decimal places (e.g., 32.16).)

  Aftertax cost of debt

Jiminy's Cricket Farm issued a 30-year, 10.8 percent semiannual bond 5 years ago. The bond currently sells for 84.5 percent of its face value. The company’s tax rate is 40 percent.

Explanation / Answer

the pre tax cost of debt is calculated as per the excel formula =rate(nper,pmt,pv,fv) where

nper = 30 years, Since semiannual 60 periods

pmt = 10.8%/2 = 0.054 = $54

pv = 84.5% of 1000 = $845

fv=1000

Hence rate =rate(60,54,845,1000) = 6.42%. This is semi annual rate.

Hence Anuual pre tax cost of debt = 6.42*2 = 12.84%

Now the after tax cost of debt = 12.84*(1-0.4) = 7.704% = 7.70%

After tax cost of debt is more relevant since debt has tax advantage and we need to consider the after tax cost of debt.

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