Question

Suspect Corp. issued a bond with a maturity of 20 years and a semiannual coupon rate of 8 percent 3 years ago. The bond currently sells for 96 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 calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Pretax cost of debt             %

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

Aftertax 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

2 1,000 8% 1 8 A A Face value (FV) B Coupon rate C Number of compounding periods per year AxB:C Interest per period (PMT) Bond price (PV) D Number of years to maturity Number of compounding periods till DxC maturity (NPER) Pre-tax cost of debt 80 960 10 171 17 12 RATE(NPER,PMT,-PV,FV)]*1 Pre-tax cost of debt 8.45% ERATE(17,80,-960,1000)x1 After-tax cost of debt 5.49% 8.45%/(1-35%) After tax cost of debt is more relevant. Interest is tax deductible expense.

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