Jiminy\'s Cricket Farm issued is bond with 15 years to maturity and a semiannual

Question

Jiminy's Cricket Farm issued is bond with 15 years to maturity and a semiannual coupon rate of 10 percent 4 years ago The bond currently sells for 91 percent of its face value. The company is 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.) Pretax cost of debt percentage 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.) Aftertax cost of debt percentage Which is more relevant the pretaxz or the aftertax cost of debt? Aftertax cost of debt Pretax cost of debt

Explanation / Answer

Answer:

Face value has not been given here. It has been assumed to be $1000.

There are n= 15-4 = 11 years to maturity = 22 semiannual periods to maturity

Coupon = 10% x 1000 = $100 annually = $50 semi-annually

Current price of Bond = 1000 * 91% = 910

Now we need to calculate yield to maturity in order to find out pre-tax cost of debt.

910 = (50/r) ( 1- (1+r)^(-22) ) + [ 1000/ (1+r)^22 ]

r = 5.73% semiannually

r = 5.73% *2 = 11.46% annually

Pre-tax cost of debt = 11.46%

Post-tax cost of debt = 11.46% * (1 - .35(tax rate))

= 7.45%

After tax cost of debt is more relevant as it can be easily compared with other cost of funding such as cost of equity, cost of preference shares.

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