Assume a firm has 20-year, 8% coupon bonds with a current market yield of 10%. With a combined federal and state corporate tax rate of 40%, the firm's after-tax cost of debt is:

Question

Quizplus · Accepted Answer

First, find the bond's price using the current market yield:
PV = (8/0.08) [1 − 1/(1+0.1)20] + 1000/ (1+0.1)20 = $667.38

Next, calculate the after-tax cost of debt:
Coupon payment = 0.08 * $1000 = $80
After-tax coupon payment = $80 * (1-0.4) = $48
PV of after-tax coupon payments = (48/0.1) [1 - 1/(1+0.1)20] = $443.86
PV of principal repayment = $1000 / (1+0.1)20 = $148.64
Total after-tax cost of debt = ($443.86 + $148.64)/$667.38 = 0.06 or 6.0%

Assume a Firm Has 20-Year, 8% Coupon Bonds with a Current