Shanken Corp. issued a 20-year, 5.4 percent semiannual bond 3 years ago. The bond currently sells for 105 percent of its face value. The company's tax rate is 24 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.)

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.)

c. Which is more relevant, the pretax or the aftertax cost of debt?

Question

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andromache andromache · Answer 1 · 2019-12-05T06:06:18+01:00

Answer:

a. 5%

b. 3.8%

c. After tax cost of debt

Explanation:

In this question, we use the Rate formula which is shown in the spreadsheet.

The NPER represents the time period.

Given that,

Present value = $1,000 × 105% = $1,050

Assuming figure - Future value or Face value = $1,000

PMT = 1,000 × 5.4% ÷ 2 = $27

NPER = 20 years × 2 = 40 years

The formula is shown below:

= Rate(NPER;PMT;-PV;FV;type)

The present value come in negative

So, after solving this,

a. The pretax cost of debt is 5%

b. And, the after tax cost of debt would be

= Pretax cost of debt × ( 1 - tax rate)

= 5% × ( 1 - 0.24)

= 3.8%

c. After tax cost of debt is more relevant as it consider the tax effect