Question

Jiminy’s Cricket Farm issued a 30 year, 8%, semi-annual bond 3 years ago. The bond currently sells for 93% of its face value. The company’s tax rate is 35%. (Hint: Notice that the bonds were issued 3 years ago and be sure to take that into account when calculating years to maturity). • What is the pretax cost of debt? • What is the after tax cost of debt?

Answer 1

The pretax cost of debt= 8.68%

The after tax cost of debt=5.65%

Step-by-step explanation:

N=30-3

N=27×2

N=54

PV=-930

Pmt=80/2

=40

FV= 1000

I/Y=4.34%

Coupon= 1000×0.08

= 80

YTM= 4.34×2

= 8.68%

The pretax cost of debt= 8.68%

To find the after tax cost of debt=?

After tax cost of debt=1-tax rate

= 1-0.35

= 0.65

YTM(1-tax rate)= 8.69(0.65)

= 5.65%

The after tax cost of debt=5.65%