ADK has 30,000 15-year, 9 percent semi-annual coupon bonds outstanding. If the bonds currently sell for 90 percent of par and the firm pays an average tax rate of 32 percent, what will be the before-tax and after-tax component cost of debt?

Question

Quizplus · Accepted Answer

The before-tax cost of debt can be calculated using the following formula:
Before-tax cost of debt = (semi-annual coupon payment / Bond price) x 2
= (0.09 x 1000 / 2) / (0.90 x 1000)
= 0.05 or 5%

The after-tax cost of debt can be calculated as follows:
After-tax cost of debt = Before-tax cost of debt x (1 - Average tax rate)
= 5% x (1 - 0.32)
= 3.4%

Therefore, the before-tax and after-tax component cost of debt are 10.32 percent and 7.02 percent, respectively. Option B is the correct answer.

ADK Has 30,000 15-Year, 9 Percent Semi-Annual Coupon Bonds Outstanding