Watkins Co.is issuing a 10-year, $1000 par value bond that pays 9% interest annually.The bond is expected to sell for $885.What is Watkins Co.'s after-tax cost of debt if the firm is in the 34% tax bracket?

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Quizplus · Accepted Answer

The after-tax cost of debt can be calculated using the formula: After-tax cost of debt = (Annual interest payment + (Par value - Issue price) / Years to maturity) / (Issue price + Par value) / 2 * (1 - Tax rate). Plugging in the values: Annual interest = 9% of $1000 = $90; Par value - Issue price = $1000 - $885 = $115; Years to maturity = 10; Issue price = $885; Par value = $1000; Tax rate = 34%. After-tax cost of debt = ($90 + ($115 / 10)) / (($885 + $1000) / 2) * (1 - 0.34) = 7.23%.