Jiminy's Cricket Farm issued a 20-year, 7 percent semiannual coupon bond 4 years ago. The bond currently sells for 104 percent of its face value. The company's tax rate is 23 percent. a. What is the company's pretax cost of debt?

Question

Business

Gilberto Ho

30 September, 22:20

Jiminy's Cricket Farm issued a 20-year, 7 percent semiannual coupon bond 4 years ago. The bond currently sells for 104 percent of its face value. The company's tax rate is 23 percent. a. What is the company's pretax cost of debt?

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Answers (1)

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Meadow Dunlap · Answer 1

6.64%

Explanation:

The pretax cost of debt is the Yield to Maturity (YTM). Since the coupons are paid semiannually, adjust the duration and the coupon payment amount to semi-annual terms.

You can solve for the YTM using a financial calculator with the following inputs;

Maturity of the bond; N = 20*2 = 40

Face value; FV = 1000

Semi-annual coupon payment; PMT = (7%/2) * 1000 = 35

Current price of the bond; PV = - 1.04*1000 = - 1040

Then compute the semiannual interest rate; CPT I/Y = 3.318%

Therefore, pretax cost of debt; YTM = 3.318 * 2 = 6.64%