Question

Shanken Corp. issued a 20-year, 5.4 percent semiannual bond 3 years ago. The bond currently sells for 105 percent of its face value. The company's tax rate is 24 percent.

a.


What is the pretax cost of debt? (Do not round intermediate calculations and 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 and 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?

Answer 1

The pretax cost of debt can be calculated by finding the yield to maturity (YTM) of the bond. The aftertax cost of debt takes into account the tax rate. The aftertax cost of debt is more relevant because it reflects the actual cost to the company after taking into account the tax benefits of interest expense.

Step-by-step explanation:

a. To calculate the pretax cost of debt, we need to find the yield to maturity (YTM) of the bond.

The YTM can be calculated using the bond's current price, face value, coupon rate, and time to maturity.

In this case, the bond currently sells for 105 percent of its face value, so the current price would be 1.05 times the face value. We can then use a financial calculator or spreadsheet function to find the YTM.

The pretax cost of debt is equal to the YTM, which can be expressed as a percentage.

b. The aftertax cost of debt takes into account the tax rate.

To calculate the aftertax cost of debt, we need to multiply the pretax cost of debt by (1 - tax rate).

In this case, the tax rate is 24 percent, so the aftertax cost of debt would be the pretax cost of debt multiplied by (1 - 0.24).

c. The aftertax cost of debt is more relevant because it reflects the actual cost to the company after taking into account the tax benefits of interest expense.

The aftertax cost of debt is the cost that the company will effectively pay after considering the tax savings.

Answer 2

a. 5%

b. 3.8%

c. After tax cost of debt

Step-by-step explanation:

In this question, we use the Rate formula which is shown in the spreadsheet.

The NPER represents the time period.

Given that,

Present value = $1,000 × 105% = $1,050

Assuming figure - Future value or Face value = $1,000

PMT = 1,000 × 5.4% ÷ 2 = $27

NPER = 20 years × 2 = 40 years

The formula is shown below:

= Rate(NPER;PMT;-PV;FV;type)

The present value come in negative

So, after solving this,

a. The pretax cost of debt is 5%

b. And, the after tax cost of debt would be

= Pretax cost of debt × ( 1 - tax rate)

= 5% × ( 1 - 0.24)

= 3.8%

c. After tax cost of debt is more relevant as it consider the tax effect