Jiminy’s Cricket Farm issued a bond with 25 years to maturity and a semiannual c

Question

Jiminy’s Cricket Farm issued a bond with 25 years to maturity and a semiannual coupon rate of 12 percent 3 years ago. The bond currently sells for 94 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 25 years to maturity and a semiannual coupon rate of 12 percent 3 years ago. The bond currently sells for 94 percent of its face value. The company’s tax rate is 35 percent.

Explanation / Answer

  K =Nx2         
BOND PRICE= [(Semi-annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^(Nx2)
                   k=1

                    K= (25-3)x2          
940 = [(12*1000/(100*2))/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^(25-3)x2
                   k=1

a Before tax cost of debt (YTM) = 12.82%

b After tax cost of debt = YTM(1-tax rate) = 12.822*(1-0.35) = 8.33%

c After tax cost of capital is more relevant as that is the cost that the firm actually pays for raising the debt

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