Shanken Corp. issued a 25-year, 6 percent semiannual bond 2 years ago. The bond

Question

Shanken Corp. issued a 25-year, 6 percent semiannual bond 2 years ago. The bond currently sells for 92 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 and 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 and 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?

Shanken Corp. issued a 25-year, 6 percent semiannual bond 2 years ago. The bond currently sells for 92 percent of its face value. The company's tax rate is 35 percent.

Explanation / Answer

a.

n = ( 25 -2) x 2 = 46 semiannual periods to maturity.

Par value of the bond is $ 1,000.

Present value of the bond is $ 920.

Semiannual coupon = $ 1,000 x 6% x 1/2 = $ 30.

Pretax cost of debt ( r) = ?

920 = 30/r x [ 1 - ( 1+r)^( -46) ] + [ 1,000 / (1 + r) ^46]

r = 3.34 %

Pretax cost of debt = 3.34 % x 2 = 6.68 %

b.

c. After tax cost of debt is more relevant, as an after tax discount rate should be employed to discount after tax cash flows.

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