Compute the after tax cost of debt given that the firm's current yield to maturity on debt is 10% and the debt pays a 8% coupon. Let the current tax rate equal 37.8%. Write your answer as a decimal.
Debt financing entails payment of periodic interest for the time period the debt is borrowed. At the end of the borrowing period, the original principal or the borrowed amount is returned.
Answer and Explanation:
The after-tax cost of debt is 0.0622.
The after-tax cost of debt can be calculated by using the following formula:
After-tax Cost of Debt = Yield to maturity * (1 - Tax Rate)
It is given in the question that the firm has
- Yield to maturity = 10%
- Tax Rate = 37.8%
Substituting the values in the formula, we get
After-tax Cost of Debt
= 10% * (1 - 0.378)
= 10% * 0.622
= 6.22% or 0.0622
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from Financial Accounting: Help and ReviewChapter 8 / Lesson 7