High Road Tours has an aftertax cost of debt of 5.1 percent at its current tax rate of 34 percent.What will its aftertax cost of debt be if the tax rate drops to 21 percent? Assume all interest is tax deductible.

Question

Quizplus · Accepted Answer

Using the formula for aftertax cost of debt:
Aftertax Cost of Debt = (1 - Tax Rate) x Cost of Debt
At a tax rate of 34%, the aftertax cost of debt is:
Aftertax Cost of Debt = (1 - 0.34) x 0.051 = 0.03366 or 3.366%
At a tax rate of 21%, the aftertax cost of debt is:
Aftertax Cost of Debt = (1 - 0.21) x 0.051 = 0.04029 or 4.029%
Therefore, the aftertax cost of debt increases to 6.10% if the tax rate drops to 21%. Thus, the answer is A.

High Road Tours Has an Aftertax Cost of Debt of 5.1