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A company's current balance sheet shows three different types of long-term debt. One is $30,000...

Question:

A company's current balance sheet shows three different types of long-term debt. One is $30,000 at the interest rate of 15%; another is $50,000 at 8%. The last one is $20,000 at 6%. If the company's income tax rate is 35%, what is the after-tax interest rate of this company on its entire debt?

Cost of Debt in Case of Multiple Debts:


Sometimes more than one debt exists in a company's balance-sheet. In such cases, the cost of debt is calculated as per the weights of each individual debt and then combined together to arrive at the cost of the entire debt.

Answer and Explanation:


After-tax interest rate on the entire debt of the company:

Kd = 30,000/$100,000 x 15% x (1 - 0.35) + 50,000/$100,000 x 8% x (1 - 0.35) + 20,000/$100,000 x 6% x (1 - 0.35)

= 0.3 x 9.75% + 0.5 x 5.2% + 0.2 x 3.9%

= 6.305%


Learn more about this topic:

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Long-Term Debt: Definition, Cost & Formula

from Financial Accounting: Help and Review

Chapter 8 / Lesson 7
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