Question

Jiminy’s Cricket Farm issued a 20-year, 6 percent semiannual bond 2 years ago. The bond currently sells for 92 percent of its face value. The company’s tax rate is 35 percent.

a.	What is the pretax cost of debt? (Do not round intermediate calculation and round your answer to 2 decimal places. (e.g., 32.16))

Cost of debt

%

b.	What is the aftertax cost of debt? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16))

Cost of debt

%

c.

Which is more relevant, the pretax or the aftertax cost of debt?

	Aftertax cost of debt
	Pretax cost of debt

Answer 1

a) The pre-tax cost of debt = Yield to maturity of the bond

N = 20*2 = 40

PV = -92

PMT = 100*0.06/2 = 3

FV = 100

CPT I/Y = 3.36692262

Yield to maturity = 3.36692262% * 2 = 6.73384524%

The pre-tax cost of debt = 6.73384524%

b) After-tax cost of debt = 6.73384524% * (1 - 0.35)

After-tax cost of debt = 0.04376999406 = 4.376999406%

c) The after-tax cost of debt is more relevant because the interest paid on the bonds is tax deductible.

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