Jimmy\'s Cricket Farm issued a 30-year, 9 percent semiannual bond 7 years ago. T

Question

Jimmy's Cricket Farm issued a 30-year, 9 percent semiannual bond 7 years ago. The bond currently sells for 89 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 percentage 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 percentage rounded to 2 decimal places (e.g., 32.16).) Which is more relevant, the pretax or the aftertax cost of debt?

Explanation / Answer

We are not told a face value, so Let us assume a $1000 face value.

There are n= 30-7 = 23years to maturity = 46 semiannual periods to maturity

Coupon = 9% x 1000 = $90 annually = $45 semi-annually

Current market price is = 940


therefore, set up the value equation

890 = (45/r) (1- (1+r) ^ (-46)) + [1000/ (1+r) ^46]

guess and check for values of r. Note: r is a semiannual rate.

The bond sells at a discount, so therefore the yield to maturity must be more than the coupon rate (i.e. more than 9% / 2 = 4.5% semiannually)

so, while solving the questions interest rate will be 10.256% annually and 5.128% semiannually.

       Ans: 10.26%

       Ans: = 10.26(1-0.35) Where 0.35 is tax rate

               = 6.67%

      Ans: After tax cost is more relevant as you need an after tax discount rate to discount after tax cash flows. Company gets the Tax rebate on the amount paid as interest.

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