Question

Jiminy’s Cricket Farm issued a 30-year, 5 percent semiannual coupon bond 6 years ago. The bond currently sells for 106 percent of its face value. The company’s tax rate is 25 percent. |

a. |
What is the company’s pretax cost of debt? |

b. |
What is the company’s 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.) |

Answer #1

Cost of Debt = [Coupon + Pro-rated Discount]/[(Purchase Price + Redemption Price)/2]

Where,

Coupon = Par Value*Coupon Rate = 1000*5%/2 = 25

Pro Rated Discount = [(Redemption Price-Purchase Price)/Period to Maturity] = [(1000-1060)/(30*2)] = -1

Redemption Price(assuming at par) = 1000

Therefore, Kd = [25-1]/[(1060+1000)/2] = 24/1030 = 0.0233 = 2.33%

Above Kd is Half Yearly. Therefore, Annual Kd = Half Yearly*2 =
2.33%*2 = **4.66%**

**Pre-Tax Cost of Debt = 4.66%**

**After Tax Cost of Debt =** Pre Tax Cost of
Debt*(1-Tax Rate) = 4.66(1-0.25) = **3.495 =
3.495%**

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