Jiminy’s Cricket Farm issued a 20-year, 4 percent semiannual coupon bond 6 years ago. The bond currently sells for 95 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.)
Information provided:
Par value= present value= $1,000
Current price= present value= 0.95*1,000= $950
Time= 20 years – 6 years= 14 years*2= 28 semi-annual periods
Coupon rate= 4%/2= 2%
Coupon payment= 0.02*1,000= $20
a.The pretax cost of debt is calculated by computing the yield to maturity.
Enter the below in a financial calculator to compute the yield to maturity:
FV= 1,000
PV= -950
N= 28
PMT= 20
Press the CPT key and I/Y to compute the yield to maturity.
The value obtained is 2.2424.
Therefore, the pretax cost of debt is 2.2424*2=4.48%.
b.After tax cost of debt= Before tax cost of debt*(1 – tax rate)
= 4.48%*(1 – 0.25)
= 3.36%.
In case of any query, kindly comment on the solution.
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