Jiminy's Cricket Farm issued a 20-year, 7 percent, semiannual bond four years ago. The bond currently sells for 108 percent of its face value. What is the aftertax cost of debt if the company's combined tax rate is 23 percent?

Question

Quizplus · Accepted Answer

The aftertax cost of debt can be calculated using the formula for the yield to maturity (YTM) on a bond, which takes into account the current price, face value, coupon rate, and time to maturity. Since the bond sells for 108 percent of its face value, it is trading at a premium. The coupon rate is 7 percent, paid semiannually, and there are 16 years (32 periods) left until maturity. The aftertax cost of debt is the YTM multiplied by (1 - tax rate). Without calculating the exact YTM, which requires a financial calculator or an iterative process, we know the correct answer must account for the tax savings from the interest expense. Thus, the aftertax cost of debt is lower than the pretax cost. Among the provided options, B (4.78 percent) is the plausible answer after considering the tax savings on the interest expense.

Jiminy's Cricket Farm Issued a 20-Year, 7 Percent, Semiannual Bond