Question

Himiny's Cricket Farm Issued a 25-year, 15 percent semiannual bond 3 years ago. The bond currently sells for 98 percent of its face value. The company's tax rate is 33 percent. What is the pretax cost of debt?

Answer 1

Given about Himiny's Cricket Farm's bond,

Face value = $1000

Coupon rate = 15% paid semiannually

years to maturity = (25 - 3) = 22 years

current price = 98 of face value = 98% of 1000 = $980

Semiannual coupon = (15%/2) of 1000 = $75

Yield to maturity of the bond is calculated on financial calculated using following values:

FV = 1000

PV = -980

PMT = 75

N = 2*22 = 44

Solve for I/Y, we get I/Y = 7.66

So, YTM of the bond = 2*7.66 = 15.32%

For a company, its pretax cost of debt equals to its bond's Yield to maturity.

So, Pretax Cost of debt of the company, Kd = 15.32%