Decline, Inc. is trying to determine its cost of debt. The firm has a debt issue outstanding with 15 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has an embedded cost of 11 percent annually. What is the aftertax cost of debt if the tax rate is 33 percent?

Question

Quizplus · Accepted Answer

The aftertax cost of debt is calculated by finding the yield to maturity (YTM) on the debt and then adjusting for taxes. The YTM is approximately 10.23% annually (since the bond is quoted at 107% of face value and has a coupon rate of 11%). The aftertax cost of debt is YTM * (1 - tax rate) = 10.23% * (1 - 0.33) = 6.85%, which is closest to 6.76%.