Question

Jiminy’s Cricket Farm issued a bond with 25 years to maturity and a semiannual coupon rate of 4 percent 3 years ago. The bond currently sells for 108 percent of its face value. The company’s tax rate is 22 percent.

What is the pretax cost of debt?

What is the aftertax cost of debt?

Answer 1

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =22x2

1080 =∑ [(4*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^22x2

k=1

YTM% = 3.48 = pretax cost

After tax rate = YTM * (1-Tax rate)

After tax rate = 3.48 * (1-0.22)

After tax rate = 2.71