Question

Shanken Corp. issued a 25-year, 5.5 percent semiannual bond 4 years ago. The bond currently sells for 106 percent of its face value. The company's tax rate is 25 percent. a. What is the 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 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.)

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.)

If the tax rate is 22 percent, what is the 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.)

Answer 1

Face Value = $1,000

Current Price = 106% * Face Value
Current Price = 106% * $1,000
Current Price = $1,060

Annual Coupon Rate = 5.50%
Semiannual Coupon Rate = 2.75%
Semiannual Coupon = 2.75% * $1,000
Semiannual Coupon = $27.50

Time to Maturity = 21 years
Semiannual Period = 42

Answer a.

Let Semiannual YTM be i%

$1,060 = $27.50 * PVIFA(i%, 42) + $1,000 * PVIF(i%, 42)

Using financial calculator:
N = 42
PV = -1060
PMT = 27.50
FV = 1000

I = 2.517%

Semiannual YTM = 2.517%

Pre-tax Cost of Debt = 2 * Semiannual YTM
Pre-tax Cost of Debt = 2 * 2.517%
Pre-tax Cost of Debt = 5.03%

Answer b.

Tax Rate = 25%

After-tax Cost of Debt = Pretax Cost of Debt * (1 - tax)
After-tax Cost of Debt = 5.03% * (1 - 0.25)
After-tax Cost of Debt = 3.77%