Cost of debt For which capital component must you make a tax adjustment when cal
ID: 2713424 • Letter: C
Question
Cost of debt For which capital component must you make a tax adjustment when calculating the weighted average cost of capital (WACC) for a firm? Preferred stock Debt Equity Bedrick Co. can borrow at an interest rate of 12.5% for a period of six years. Its marginal federal-plus-state tax rate is 35%. What is Bedrick's after-tax cost of debt? Bedrick Co. has outstanding 10-year noncallable bonds with a face value of $1,000. These bonds have a current market price of $1,092.79 and an annual coupon rate of 11%. The company faces a tax rate of 35%. If the company wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt? 7.43% 6.19% 5.57% 7.12%Explanation / Answer
1) debt : the company will take tax adjustment on the debt while calculating weighted average cost of capital as the interest exense paid on debt is a tax deductible expense.
2) After tax cost of debt = cost of debt * ( 1-tax rate)
=12.5% *(1-35%)
=8.125%
3)
PV = 110/(1+r)^1+ 110/(1+r)^2+ 110/(1+r)^3+ 110/(1+r)^4+ 110/(1+r)^5+ 110/(1+r)^6+ 110/(1+r)^7+110/(1+r)^8+110/(1+r)^9+110/(1+r)^10+1000/(1+r)^10
1092.79= 110/(1+r)^1+ 110/(1+r)^2+ 110/(1+r)^3+ 110/(1+r)^4+ 110/(1+r)^5+ 110/(1+r)^6+ 110/(1+r)^7+110/(1+r)^8+110/(1+r)^9+110/(1+r)^10+1000/(1+r)^10
r= 9.52%
cost of debt = 9.52%
cost of debt after tax = 9.52% * 0.65 = 6.19%