The outstanding bonds of The Purple Fiddle are priced at $898 and mature in nine years. These bonds have a 6 percent coupon and pay interest annually. The ﬁrm's tax rate is 35 percent. What is
The ﬁrm's after-tax cost of debt?

Question

Quizplus · Accepted Answer

The after-tax cost of debt is the yield to maturity (YTM) of the bond adjusted for the tax savings from the interest payments. The YTM is the annual rate of return that an investor would earn if they held the bond until maturity. The tax savings from the interest payments is the amount of taxes that the firm would save by deducting the interest payments from its taxable income.In this case, the YTM is 6 percent. The tax savings from the interest payments is 35 percent of 6 percent, or 2.1 percent. Therefore, the after-tax cost of debt is 6 percent - 2.1 percent = 3.9 percent.

The Outstanding Bonds of the Purple Fiddle Are Priced at $898