Question

A firm has an outstanding debt with a coupon rate of 55​%, seven years​ maturity, and a price of​ $1000 per​ $1000 face value. What is the​ after-tax cost of debt if the marginal tax rate of the firm is 30%?

Answer 1

Information provided:

Face value=Future value= $1,000

Time= 7 years

Coupon rate= 5%

Coupon payment= 0.05*1,000= $50

Current price= present value= $1,000

The after tax cost of debt is calculated by first computing the before tax cost of debt.

The yield to maturity is computed to calculate the before tax cost of debt.

Enter the below in a financial calculator to calculate the yield to maturity:

FV= 1,000

N= 7

PMT= 50

PV= -1,000

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 5.

Therefore, the before tax cost of debt is 5%.

After tax cost of debt= before tax cost of debt*(1 – tax)

                                        = 5%*(1 – 0.30)

                                        = 3.50%.

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