Jiminy\'s Cricket Farm issued a 30-year, 8 percent semi-annual bond 7 years ago.

Question

Jiminy's Cricket Farm issued a 30-year, 8 percent semi-annual bond 7 years ago. The bond currently sells for 84 percent of its face value. The book value of the debt issue is $19 million. The company's tax rate is 34 percent.

In addition, the company has a second debt issue on the market, a zero coupon bond with 7 years left to maturity; the book value of this issue is $84 million and the bonds sell for 79 percent of par.

What is your best estimate of the aftertax cost of debt? (Do not round your intermediate calculations.)

a. 3.59%

b. 2.31%

c. 3.05%

d. 3.42%

Jiminy's Cricket Farm issued a 30-year, 8 percent semi-annual bond 7 years ago. The bond currently sells for 84 percent of its face value. The book value of the debt issue is $19 million. The company's tax rate is 34 percent.

In addition, the company has a second debt issue on the market, a zero coupon bond with 7 years left to maturity; the book value of this issue is $84 million and the bonds sell for 79 percent of par.

What is your best estimate of the aftertax cost of debt? (Do not round your intermediate calculations.)

Explanation / Answer

C.3.05%

Interest Rate for the first Debt:

PV= $840

FV= $ 1,000

N= 23 x 2 = 46

PMT = $ 80/2 = $ 40

Solve I/Y Financial Calulator = 0.04879 = 9.76%

After tax = 9.76% (1- 34%) = 6.44%

Interest Rate for Second Debt:

PV= $790

FV= $1,000

N= 7

PMT=0

Solve I/Y Financial Calulator = 0.03425

After tax = 3.425% (1-34%)= 2.26%

Cost of Debt for Jiminy's Cricket is : (19/103) x 6.44% + (84/103) x 2.26% = 3.04%

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