Cost of Debt The _________________ (before-tax cost of debt, after-tax cost of d
ID: 2711428 • Letter: C
Question
Cost of Debt
The _________________ (before-tax cost of debt, after-tax cost of debt) is the interest rate that a firm pays on any new debt financing.
Revive Co. can borrow at any interest rate of 12.5% for a period of eight years. its marginal federal-plus state tax rate is 30%. What is Revive's after-tax cost of debt?
a. 7.5%
b. 8.8%
c. 12.5%
d. 8.4%
Revive Co. has outstanding 5-year noncallable bonds with a face value of $1,000. These bonds have a current market price of $1,229.24 and an annual coupon rate of 10%. The company faces a tax rate of 30%. If the company wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt?
a. 3.32%
b. 3.82%
c. 3.98%
d. 2.99%
Explanation / Answer
1) before-tax cost of debt
2) after tax cost of debt = before tax cost of debt * (1 - tax rate) = 12.5*(1 - .3 ) = 8.75% = 8.8%
3)
K = N
BOND PRICE= [(Coupon)/(1 + YTM)^k] + Par value/(1 + YTM)^N
k=1
K = 5
1229.24 = [(10*1000/100)/(1 + YTM/100)^k] + 1000/(1 + YTM/100)^5
k=1
YTM( before tax cost of debt) = 4.7427%
after tax cost of debt = before tax cost of debt * (1 - tax rate) = 4.7427*(1 - .3 ) = 3.32%