Simple Foods has a zero coupon bond issue outstanding that matures in 14 years. The bonds are selling at 56 percent of par value. What is the company's aftertax cost of debt if the combined tax rate is 23 percent? (Use semiannual compounding.)

Question

Quizplus · Accepted Answer

The first step is to calculate the yield to maturity (YTM) of the bond. Since the bond is selling at 56% of par value, this means that the present value of the bond's cash flows is 56% of its face value.

To calculate the YTM, we need to use an online financial calculator or a spreadsheet function such as the RATE function. Using semiannual compounding, the YTM is 6.44%.

Next, we need to calculate the aftertax cost of debt. Since the bonds are zero coupon bonds, there are no interest payments to deduct for tax purposes. Therefore, the aftertax cost of debt is simply the YTM multiplied by (1 - tax rate).

Aftertax cost of debt = 6.44% x (1 - 0.23) = 4.96%

Therefore, the answer is C) 3.22%, which is the semiannual aftertax cost of debt.

Simple Foods Has a Zero Coupon Bond Issue Outstanding That