If a corporation has an average tax rate of 40 percent, the approximate annual, aftertax cost of debtfor a 10-year, 8 percent, $1,000 par value bond selling at $1,150 is
A) 6 percent.
B) 8 percent.
C) 4.2 percent.
D) 4.8 percent.

Question

Quizplus · Accepted Answer

To calculate the aftertax cost of debt, first find the before-tax cost of debt:
Coupon payment = 8% x $1,000 = $80
Yield to maturity = ($80 annual interest + ($1,000 par value - $1,150 current price)/10 years)/($1,000 + $1,150)/2 = 6.88%
Before-tax cost of debt = yield to maturity = 6.88%
Then, calculate the after-tax cost of debt:
After-tax cost of debt = before-tax cost of debt x (1 - average tax rate)
= 6.88% x (1 - 0.40)
= 4.13%
Therefore, the approximate annual, aftertax cost of debt for this bond is 4.2%. Option C is the only one close to this value.

If a Corporation Has an Average Tax Rate of 40