The aftertax cost of debt generally increases when:
I.a firm's bond rating increases.
II.the market rate of interest increases.
III.tax rates decrease.
IV.bond prices rise.
A)I and III only
B)II and III only
C)I, II, and III only
D)II, III, and IV only
E)I, II, III, and IV

Question

Quizplus · Accepted Answer

The aftertax cost of debt is calculated as the pre-tax cost of debt multiplied by (1 - tax rate). Therefore, it decreases when tax rates decrease (option III) and increases when the market rate of interest increases (option II). The bond rating and prices have an inverse relationship with the cost of debt, so when a firm's bond rating increases (option I) or bond prices rise (option IV), the cost of debt decreases. Therefore, options I and IV are incorrect. The best choice is B, with options II and III only.

The Aftertax Cost of Debt Generally Increases When