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? (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 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%