The approximate aftertax cost of debt for a 20-year, 7 percent, $1,000 par value bond selling at $960(assume a marginal tax rate of 40 percent) is
A) 5.2 percent.
B) 7.3 percent.
C) 4.4 percent.
D) 7 percent.

Question

Quizplus · Accepted Answer

The after-tax cost of debt is calculated as:
After-tax cost of debt = Pre-tax cost of debt x (1 - Marginal tax rate)
Pre-tax cost of debt = 7%
Marginal tax rate = 40%
After-tax cost of debt = 7% x (1 - 0.40) = 4.2%
The bond is selling at a discount, which means the effective yield is higher than the coupon rate. However, the after-tax cost of debt is lower than the coupon rate, which indicates that the company is getting a tax benefit on its interest payments. Therefore, the best choice is C.

The Approximate Aftertax Cost of Debt for a 20-Year, 7