Question

Jiminy’s Cricket Farm issued a 30‐year, 6 percent semiannual bond 8 years ago. The bond currently sells for 107 percent of its face value. The company’s tax rate is 35 percent. What is the pretax cost of debt, and what is the after tax cost of debt? SHOW YOUR WORK

A. Pretax cost of debt is 5.45% and after‐tax cost of debt is 3.54%

B. Pretax cost of debt is 2.72% and after‐tax cost of debt is 1.77%

C. Pretax cost of debt is 5.45% and after‐tax cost of debt is 2.72%

D. Pretax cost of debt is 2.72% and after‐tax cost of debt is 3.54%

Answer 1

A. Pretax cost of debt is 5.45% and after‐tax cost of debt is 3.54%

Yield To Maturity(YTM) = (interest per period+ ((Redemption price - Current market price) / life remaining to maturity)) / ((.4*Redemption price)+ (.6*Current market price))

= ((1000*6%/2)+ ((1000-1070) / (30-8)*2)) / ((.4*1000)+ (.6*1070))

= (30+ (-70/44) / (400+642)

= 28.4090909091/1042

= 0.02726400279

Pretax cost of debt =  0.02726400279*2

= 5.45%

after‐tax cost of debt = 5.45*(1-.35)

= 3.54%

note: It is general practice to take $1,000 as face value when no details are given.