Nico Trading Corporation is considering issuing long-term debt. The debt would have a 30-year maturity and a 10 percent coupon rate. In order to sell the issue, the bonds must be underpriced at a discount of 5 percent of face value. In addition, the firm would have to pay flotation costs of 5 percent of face value. The firm's tax rate is 35 percent. Given this information, the after-tax cost of debt for Nico Trading would be ________.
A) 7.26%
B) 11.17%
C) 10.00%
D) 9.00%

Question

Quizplus · Accepted Answer

The after-tax cost of debt is calculated by adjusting the interest cost for taxes, since interest expense is tax-deductible. The discount and flotation costs affect the initial proceeds from the bond but do not directly affect the annual interest payments or the tax shield from those payments. The coupon rate is 10%, and the tax rate is 35%, so the after-tax cost of debt is 10% * (1 - 0.35) = 6.5%. However, the discount and flotation costs effectively increase the cost of issuing the debt. Since the question specifically asks for the after-tax cost of debt considering these factors, and given the options provided, it seems there might be a misunderstanding in the calculation process. The correct approach involves calculating the effective interest expense including the discount and flotation costs, then adjusting for taxes. However, without the explicit calculation provided in the options, the closest estimate based on the given information and typical calculation methods would be to focus on the tax-adjusted coupon rate, which seems to have been intended to be reflected in option A, acknowledging a potential misinterpretation in the calculation process described.

Nico Trading Corporation Is Considering Issuing Long-Term Debt