Jiminy\'s Cricket Farm issued a 30-year, 8.4 percent semiannual bond 9 years ago

Question

Jiminy's Cricket Farm issued a 30-year, 8.4 percent semiannual bond 9 years ago. The bond currently sells for 90.5 percent of its face value. The company’s tax rate is 30 percent.

Required: (a) 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).) Pretax cost of debt %

(b) 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 %

(c) Which is more relevant, the pretax or the aftertax cost of debt?

Explanation / Answer

Jimmy's Cricket team YTM formula = {Interest payment+(Face value-Market price)/Years to maturity}/(face value+2*market price)/3 Details Face value assumed                        1,000 Market Price                            905 Annual Interest                              84 Years to maturity                              21 YTM =[84+(1000-905)/21]/(1000+905*2)/3 YTM =9.45% aaprox a So pretax cost of debt = 9.45% b Tax rate                                0 Post Tax cost of debt=PreTax cost of debt*(1-Taxrate) =0.0945*(1-0.3) 6.62% So post tax cost of debt is 6.62% c Post Tax cost is more important as that indicates the net cost of the debt after considering interest tax shield of debt.

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