Jiminy's Cricket Farm issued a 30-year, 7.8 percent semiannual bond 5 years ago. The bond currently sells for 92 percent of its face value. The company's tax rate is 40 percent. Required: (a) What is the pretax cost of debt? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e. g., 32.16).) Pretax cost of debt % (b) What is the aftertax cost of debt? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e. g., 32.16).) Aftertax cost of debt % (c) Which is more relevant, the pretax or the aftertax cost of debt?

Pretax cost of debt is 8.58%

after tax cost of debt is 5.15%

After tax cost of debt of 5.15% is more relevant because that reflects the true cost of debt bearing in mind that debt has a tax advantage (tax shield).

Explanation:

The pretax cost of debt can be computed using the rate formula in excel as follows:

=rate (nper, pmt,-pv, fv)

nper is the number of coupons the bond would pay i. e 25years (years to maturity) * 2=50

pmt is the semiannual coupon interest=$1000*7.8%*6/12=$39

pv is the present price of the bond=$1000*92%=$920

fv is the face value of $1000

=rate (50,39,-920,1000) = 4.29%

Annual yield=4.29%*2=8.58%

after tax cost of debt=pretax cost of debt * (1-t)

t is the tax rate of 40%

after tax cost of debt=8.58% * (1-0.4) = 5.15%