The long-term debt of Laurentide Union Bank is currently selling at 103.The issue matures in 20 years and pays an annual coupon of 8%.The corporate tax rate is 40%.What is the after-tax cost of debt for Laurentide Union?
A)3.08%
B)4.62%
C)4.80%
D)7.70%

Question

Quizplus · Accepted Answer

The after-tax cost of debt can be calculated using the formula:
After-tax cost of debt = Pretax cost of debt x (1 - Tax rate)

Pretax cost of debt can be calculated using the formula:
Pretax cost of debt = Annual coupon payment / Bond price

Coupon payment = 8% x Par value = 0.08 x 1000 = $80
Bond price = 103% x Par value = 1.03 x 1000 = $1030

Pretax cost of debt = $80 / $1030 = 0.0777 or 7.77%

After-tax cost of debt = 7.77% x (1 - 0.4) = 4.662% or 4.62% (rounded to two decimal places)

Therefore, the answer is B.

The Long-Term Debt of Laurentide Union Bank Is Currently Selling