Question

Shanken Corp. issued a 10-year, 6 percent semiannual bond 2 years ago. The bond currently sells for 95 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 and 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 and 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

a.

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =8x2

950 =∑ [(6*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^8x2

k=1

YTM% = 6.82

b.

After tax YTM = YTM*(1-tax rate) = 6.82*(1-0.35)=4.43%

c.

After tax yield is more relevant because it is finally the actual cost that the firm faces after recieving tax shield on interest payments