Jiminy’s Cricket Farm issued a 30-year, 8 percent semiannual bond 3 years ago. T

Question

Jiminy’s Cricket Farm issued a 30-year, 8 percent semiannual bond 3 years ago. The bond currently sells for 93 percent of its face value. The company’s tax rate is 35 percent.

What is the pretax cost of debt? (Do not round intermediate calculation and round your answer to 2 decimal places. (e.g., 32.16))

What is the aftertax cost of debt? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16))

Jiminy’s Cricket Farm issued a 30-year, 8 percent semiannual bond 3 years ago. The bond currently sells for 93 percent of its face value. The company’s tax rate is 35 percent.

Explanation / Answer

What is the pretax cost of debt?

The bond pays semi-annual interest of 8% of its face value, of $1,000. That's $80 per year on a bond selling at $930 (1,000 x .93). Cost of debt before tax then is 80 / 930, or 8.60%

What is the aftertax cost of debt?

Since interest expense is tax deductible, the 80 reduces tax by 35%, or 28, for a net after tax cost of 52 (or 1.00 - .35 = .68 x 80). Cost of debt after tax then is 52 / 930, or 5.59%

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