The approximate after-tax cost of debt for a 20-year, 7 percent, $1,000 par value bond selling at $960 (assume a marginal tax rate of 40 percent) is
A) 4.41 percent.
B) 5.15 percent.
C) 7 percent.
D) 7.35 percent.

Question

Quizplus · Accepted Answer

The after-tax cost of debt is the yield to maturity adjusted for the tax savings on the interest payments. The yield to maturity is the annual interest payment divided by the bond price. The annual interest payment is $70 ($1,000 * 7%). The bond price is $960. Therefore, the yield to maturity is 7.29% ($70/$960). The after-tax cost of debt is the yield to maturity multiplied by (1 - the marginal tax rate). The marginal tax rate is 40%. Therefore, the after-tax cost of debt is 4.41% (7.29% * (1 - 0.40)).

The Approximate After-Tax Cost of Debt for a 20-Year, 7