Jiminy\'s Cricket Farm issued a 30-year, 10 percent semiannual bond 7 years ago.

Question

Jiminy's Cricket Farm issued a 30-year, 10 percent semiannual bond 7 years ago. The bond currently sells for 86.5 percent of its face value. The company’s tax rate is 35 percent.

What is the pretax cost of debt? %?

What is the aftertax cost of debt? %?

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

How would you figure this out?

What is the pretax cost of debt? %?

What is the aftertax cost of debt? %?

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

How would you figure this out?

Explanation / Answer

Face value (FV) $                                  1,000.00 Coupon rate 10.00% Number of compounding periods per year 2 Interest per period (PMT)                                            50.00 Bond price (PV) $                                   (865.00) Number of years to maturity 23 Number of compounding periods till maturity (N) 46 Bond Yield to maturity RATE(NPER,PMT,PV,FV)*2 Bond Yield to maturity 11.70% (Pre-tax cost of debt) Bond Yield to maturity 7.61% (After-tax cost of debt) 11.70%*(1-35%) After tax cost of debt is more relevant. Since, interest is tax deductible.

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