Question

Jiminy’s Cricket Farm issued a 20-year, 7 percent semiannual bond four years ago. The bond currently sells for 98 percent of its face value. The company’s tax rate is 25 percent. What is the aftertax cost of debt?

Select one:

A. 7.68%

B. 3.61%

C. 7.21%

D. 5.41%

E. 5.89%

Answer 1

After Tax Cost of debt = YTM * ( 1 - Tax rate )

Balance left years = 20 - 4

= 16 Years

YTM is the rate at which PV of Cash Inflows are equal to Bond Price.

Period	Cash Flow	PVF/[email protected]	PV of Cash Flows	PVF/[email protected]	PV of Cash Flows
1-32	$                  35.00	19.0689	$                        667.41	17.8736	$                     625.57
32	$             1,000.00	0.3326	$                        332.59	0.2851	$                     285.06
PV of Cash Inflows	$                    1,000.00		$                     910.63
PV of Cash Oiutflows	$                        980.00		$                     980.00
NPV	$                          20.00		$                     -69.37

YTM per 6M = Rate at which least +ve NPV + [ NPV at that rate / Change in NPV due to Inc of 0.5% in Int Rate ] * 0.5%

= 3.5% + [ 20 / 89.37] * 0.5%

= 3.5% + [ 0.22 * 0.5% ]

= 3.5% + 0.11%%

= 3.61%

YTM per anum = YTM per 6M * 12 / 6

= 3.61% * 2

= 7.22%

After Tax Cost of debt = YTM * ( 1 - Tax rate )

= 7.22% * ( 1 - 0.25)

= 7.22% * 0.75

= 5.41%

Option D is correct.