Jiminy’s Cricket Farm issued a bond with 25 years to maturity and a semiannual c

Question

Jiminy’s Cricket Farm issued a bond with 25 years to maturity and a semiannual coupon rate of 10 percent 4 years ago. The bond currently sells for 97 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 percent 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 percent rounded to 2 decimal places, e.g., 32.16.)

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

Jiminy’s Cricket Farm issued a bond with 25 years to maturity and a semiannual coupon rate of 10 percent 4 years ago. The bond currently sells for 97 percent of its face value. The company’s tax rate is 35 percent.

Explanation / Answer

No of years left= 25-4 = 21 years

N=No of periods= 21 x2=42

FV=Face Value= $1,000

Coupon Amount = $1,000 x 10%=100 p.a for six months = 50 hence PMT= 50

Use Financial Calculator

N=42

PV = -970
PMT = 100/2 = 50
FV = 1000

Solve:
I/Y = 5.175 x 2 = 10.35%

a) What is the pretax cost of debt?

Ans:Pre cost of Debt= 10.35%

b) What is the aftertax cost of debt?

Ans:  Aftertax cost of debt= Pretax cost of Debt x ( 1- Tax rate)

                                   =10.35% x (1-0.35)

                                 =10.35 x 0.65

                                    =6.73%

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

Ans: After tax cost of Debt

As an tax advantage is there because that is actual cost to company.

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