Klein Corp. can issue $1,000 par value bond that pays $90 per year in interest at a price of $980. The bond will have a 10-year life. The firm is in a 35% tax bracket. What is the after-tax cost of debt?

Question

Quizplus · Accepted Answer

To calculate the after-tax cost of debt, we must first calculate the before-tax cost of debt, which is the coupon rate divided by the bond price:

Coupon rate = annual interest payment / par value = $90 / $1,000 = 9% 
Before-tax cost of debt = 9% / $980 = 0.0918 or 9.18%

Next, we calculate the after-tax cost of debt by multiplying the before-tax cost by (1 - tax rate):

After-tax cost of debt = before-tax cost of debt x (1 - tax rate) 
= 9.18% x (1 - 0.35) 
= 5.967% or 5.87%

Therefore, the best choice is (B) 9.30%.