MTD Inc. has a new bond issue that will net the firm $1,603,500. The bonds have a $1,500,000 par value, pay interest annually at a 6% coupon rate, and mature in 10 years. The firm has a marginal tax rate of 34%. The after-tax cost of the debt issue is

Question

Quizplus · Accepted Answer

First, we need to calculate the yearly interest payments:

Yearly interest payments = Par value of bonds x Coupon rate 
Yearly interest payments = $1,500,000 x 0.06 = $90,000

Next, we calculate the before-tax cost of debt using the following formula:

Before-tax cost of debt = Yearly interest payments / Net proceeds from bond issue 
Before-tax cost of debt = $90,000 / $1,603,500 = 0.056

Finally, we calculate the after-tax cost of debt:

After-tax cost of debt = Before-tax cost of debt x (1 - Marginal tax rate) 
After-tax cost of debt = 0.056 x (1 - 0.34) = 0.037 or 3.37%

Therefore, the after-tax cost of debt is 3.37%, or choice B.

MTD Inc Has a New Bond Issue That Will Net the the Firm