Jiminy’s Cricket Farm issued a bond with 30 years to maturity and a semiannual c

Question

Jiminy’s Cricket Farm issued a bond with 30 years to maturity and a semiannual coupon rate of 8 percent 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 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?

Jiminy’s Cricket Farm issued a bond with 30 years to maturity and a semiannual coupon rate of 8 percent 3 years ago. The bond currently sells for 93 percent of its face value. The company’s tax rate is 35 percent.

Explanation / Answer

Face Value = $1,000

Current Price = $930

Maturity = 27

Number of period = 27*2 = 54

Semi-annual coupon = 8%/2 = 4% = $40

Using 'RATE' function in excel,

(a) Before-tax Cost of Debt = 4.34%

(b) After-tax cost of debt = 4.34*(1-.35) = 2.82%

(c) After-tax cost of debt is more relevant as bond interests are tax deductible

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