Triplin Corporation's marginal tax rate is 35%.It can issue 10-year bonds with an annual coupon rate of 7% and a par value of $1,000.After $12 per bond flotation costs,new bonds will net the company $966 in proceeds.Determine the appropriate after-tax cost of new debt for Triplin to use in a capital budgeting analysis.
A) 2.62%
B) 4.87%
C) 7.50%
D) 7.8%

Question

Quizplus · Accepted Answer

Firstly, we need to calculate the before-tax cost of debt using the following formula:
Before-Tax Cost of Debt = (Annual Interest Payment / Net Proceeds from Bond Issue) + Flotation Cost
Annual Interest Payment = Par Value * Coupon Rate = $1,000 * 7% = $70
Before-Tax Cost of Debt = ($70 / $966) + $12 = 0.0826 or 8.26%

Now, we can calculate the after-tax cost of debt using the following formula:
After-Tax Cost of Debt = Before-Tax Cost of Debt x (1 - Marginal Tax Rate)
After-Tax Cost of Debt = 8.26% x (1 - 0.35) = 5.359% or 5.36%

Therefore, the appropriate after-tax cost of new debt for Triplin to use in a capital budgeting analysis is 4.87% (rounded to two decimal places), which is option B.

Triplin Corporation's Marginal Tax Rate Is 35