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Calculate the after-tax cost of debt under each of the following conditions: a. rd of 13%, tax...

Question:

Calculate the after-tax cost of debt under each of the following conditions:

a. rd of 13%, tax rate of 0%

b. rd of 13%, tax rate of 20%

c. rd of 13%, tax rate of 35%

Debt Cost:

This question requires knowledge of debt, which is an obligation due from a borrower, or issuer, to an investor. For a corporate borrower, the cost of debt is an important consideration in establishing an optimal capital structure.

Since interest expense is tax deductible, the after-tax cost of debt is most relevant. It is computed as follows:

After-tax Cost of Debt = Effective Annual Interest Rate * (1 - Effective Tax Rate)

Answer and Explanation:

The answers are as follows:

a. Cost of Debt = .13 (1 - .00) = .1300 or 13.00%

b. Cost of Debt = .13 (1 - .20) = .0104 or 10.40%

c. Cost of Debt = .13 (1 - .35) = .0845 or 8.45%


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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