Jiminy’s Cricket Farm issued a 15-year, 6 percent semiannual bond 2 years ago. T
ID: 2738557 • Letter: J
Question
Jiminy’s Cricket Farm issued a 15-year, 6 percent semiannual bond 2 years ago. The bond currently sells for 95 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 calculation and round your answer to 2 decimal places. (e.g., 32.16)) Cost of debt 6.97 % b. What is the aftertax cost of debt? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16)) Cost of debt 4.53 % c. Which is more relevant, the pretax or the aftertax cost of debt?
Explanation / Answer
Assume face value of bond as 1000 Rupees, tax @ 35%
15 years, 6% semi annual bond issued 2 years ago
Current market price = 95% of face value = 950
No of instalments remaining = 26
Coupon payments = 1000*6% = 60 per annum = 30 per half year
Cost of debt
3%
4%
Intrinsic value of bond
30*PVAF(3%,26 yrs) + 1000*PVIF(3%,26 yr)
30*PVAF(4%,26 yrs) + 1000*PVIF(4%,26 yr)
= 30*17.8768 + 1000*0.4637
=1000.00
=30*15.9828 + 1000*0.3607
= 840.18
3% ---->1000 950 ----> 3.31%
4% ---->840.18
Cost of debt per annum = 3.31*2 = 6.62 %
Post tax cost of debt = 6.62 (1-0.35) = 4.30 %
post tax cost of debt is more relevant .
Cost of debt
3%
4%
Intrinsic value of bond
30*PVAF(3%,26 yrs) + 1000*PVIF(3%,26 yr)
30*PVAF(4%,26 yrs) + 1000*PVIF(4%,26 yr)
= 30*17.8768 + 1000*0.4637
=1000.00
=30*15.9828 + 1000*0.3607
= 840.18
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