Rollins Corporation is constructing its marginal cost of capital (MCC) schedule. Its target capital structure is 30 percent debt, 20 percent preferred stock, and 50 percent common equity. Its bonds have a 12 percent coupon rate of interest, semiannual interest payments, a current maturity of 20 years, and a market value equal to their par value of $1,000. The firm's marginal tax rate is 40 percent. What is Rollins' after-tax cost of debt?

Question

Quizplus · Accepted Answer

The after-tax cost of debt can be calculated as follows:

- First, we need to determine the current yield to maturity (YTM) of Rollins' bonds. Since they have a 12% coupon rate and a current market value equal to their par value, the YTM is also 12%.

- Next, we need to calculate the after-tax cost of debt using the following formula:

After-tax cost of debt = YTM x (1 - Tax rate)

After-tax cost of debt = 0.12 x (1 - 0.4) = 0.072 or 7.2%

Therefore, the answer is B) 7.2%.

Rollins Corporation Is Constructing Its Marginal Cost of Capital (MCC)