Jiminy s Cricket Farm issued a 20-year, 6 percent semiannual bond 2 years ago Th

Question

Jiminy s Cricket Farm issued a 20-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 calculation and round your answer to 2 decimal places, (e.g., 32.16)) What is the aftertax cost of debt? (Do not round intermediate calculations and round your answer to 2 decimal places, (e.g., 32.16)) Which is more relevant, the pretax or the aftertax cost of debt? Aftertax cost of debt Pretax cost of debt

Explanation / Answer

years to maturity = 20 - 2 = 18 ie 36 semi-annual periods

Assume face value = 1000.

Coupon = 6% x 1000 = $60 annually = $30 semi-annually

Therefore, set up the value equation

920 = (30/r) ( 1- (1+r)^(-36) ) + [ 1000/ (1+r)^36 ]

Hence r = 3.388%  = Answer

Pre tax Cost of debt = 3.388%

After tax costof debt = Pre tax Cost of debt*(1-t) = 3.388% * (1-34%) = 2.236%  = Answer

The after tax cost of debt is more relevent = Answer

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