Question

Jiminy's Cricket Farm issued a 30-year, 7 percent semiannual coupon bond 5 years ago. The bond currently sells for 95 percent of its face value. The company's tax rate is 24 percent.

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

b.What is the company's aftertax cost of debt?

Answer 1

Face Value = $1,000

Current Price = 95% * $1,000
Current Price = $950

Annual Coupon Rate = 7.00%
Semiannual Coupon Rate = 3.50%
Semiannual Coupon = 3.50% * $1,000
Semiannual Coupon = $35

Time to Maturity = 25 years
Semiannual Period to Maturity = 50

Let Semiannual YTM be i%

$950 = $35 * PVIFA(i%, 50) + $1,000 * PVIF(i%, 50)

Using financial calculator:
N = 50
PV = -950
PMT = 35
FV = 1000

I = 3.7218%

Semiannual YTM = 3.7218%
Annual YTM = 2 * 3.7218%
Annual YTM = 7.44%

Before-tax Cost of Debt = 7.44%

After-tax Cost of Debt = 7.44% * (1 - 0.24)
After-tax Cost of Debt = 5.65%