Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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![**Understanding the Cost of Debt**
Jiminy’s Cricket Farm issued a bond with 25 years to maturity and a semiannual coupon rate of 6 percent 5 years ago. The bond currently sells for 108 percent of its face value. The company’s tax rate is 24 percent.
**Questions:**
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.)
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.)
**Solution Table:**
| | | |
|----------|-------------------------------------------|---------------|
| a. | Pretax cost of debt | \_\_\_\_% |
| b. | Aftertax cost of debt | \_\_\_\_% |
**Explanation:**
In this problem, you are asked to calculate the pretax and aftertax costs of debt for the bond issued by Jiminy’s Cricket Farm. The bond details provided are as follows:
- Original maturity: 25 years
- Remaining maturity: 20 years (since it was issued 5 years ago)
- Semiannual coupon rate: 6%
- Current price: 108% of face value
- Company’s tax rate: 24%
To solve these problems, one would typically use the following formulas:
1. **Pretax Cost of Debt**:
This can be estimated by finding the yield to maturity (YTM) on the bond. Generally, this involves solving for \( r \) in the bond pricing formula:
\[
P = \frac{C}{(1 + r)^1} + \frac{C}{(1 + r)^2} + \cdots + \frac{C+F}{(1+r)^n}
\]
Where:
- \( P \) is the current price of the bond.
- \( C \) is the coupon payment.
- \( F \) is the face value of the bond.
- \( r \) is the yield per period.
- \( n \) is the number of periods remaining.
2. **Aftertax Cost of Debt**:
This can be calculated using the formula:
\[
r_{\text](https://content.bartleby.com/qna-images/question/4075dd7b-7cf0-4080-a9ab-c20ff4793850/59f170ba-f795-4e15-961f-6a8b851e717b/xwnqcsm_processed.jpeg)
Transcribed Image Text:**Understanding the Cost of Debt**
Jiminy’s Cricket Farm issued a bond with 25 years to maturity and a semiannual coupon rate of 6 percent 5 years ago. The bond currently sells for 108 percent of its face value. The company’s tax rate is 24 percent.
**Questions:**
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.)
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.)
**Solution Table:**
| | | |
|----------|-------------------------------------------|---------------|
| a. | Pretax cost of debt | \_\_\_\_% |
| b. | Aftertax cost of debt | \_\_\_\_% |
**Explanation:**
In this problem, you are asked to calculate the pretax and aftertax costs of debt for the bond issued by Jiminy’s Cricket Farm. The bond details provided are as follows:
- Original maturity: 25 years
- Remaining maturity: 20 years (since it was issued 5 years ago)
- Semiannual coupon rate: 6%
- Current price: 108% of face value
- Company’s tax rate: 24%
To solve these problems, one would typically use the following formulas:
1. **Pretax Cost of Debt**:
This can be estimated by finding the yield to maturity (YTM) on the bond. Generally, this involves solving for \( r \) in the bond pricing formula:
\[
P = \frac{C}{(1 + r)^1} + \frac{C}{(1 + r)^2} + \cdots + \frac{C+F}{(1+r)^n}
\]
Where:
- \( P \) is the current price of the bond.
- \( C \) is the coupon payment.
- \( F \) is the face value of the bond.
- \( r \) is the yield per period.
- \( n \) is the number of periods remaining.
2. **Aftertax Cost of Debt**:
This can be calculated using the formula:
\[
r_{\text
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