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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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beritop1089

Answer:

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%

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