Shanken Corp. issued a bond with a maturity of 15 years and a semiannual coupon

Question

Shanken Corp. issued a bond with a maturity of 15 years and a semiannual coupon rate of 8 percent 3 years ago. The bond currently sells for 96 percent of its face value. The company’s tax rate is 35 percent.

a. 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).)

b. 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).)

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

Explanation / Answer

a) The pretax cost of debt is the YTM of the company's bonds, so:

Po = 960 = 40 ( PVIFA R%, 24) + 1,000 (PVIF R%, 24)

Therefore R = 4.43% (Using IRR Method)

YTM = 4.43% x 2 = 8.86%

b) After tax cost of debt = 8.86%(1 – .35) = 5.76%

c) The after tax rate is more relevant because that is the actual cost to the company.

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