Question

You have collected the following data:

The outstanding debt instrument (bonds) yield is estimated at 7.75%; the applicable tax rate is 34%; the company is expected to have its next (expected) dividend is $0.65 a share; the dividend growth rate is expected to be at a constant rate of 6.00% a year.
The current stock price is $18.00 per share; the flotation cost for issuing debt is estimated at Fd = 5%; the flotation cost for selling new shares is estimated at Fcs = 10%;
The target capital structure is 40% debt and 60% common equity.

What is the best estimate of the firm's after-tax cost of current debt?

Answer 1

Solution :-

Yield on outstanding debt is the before tax cost of debt .

So, Before Tax cost of debt = 7.75%

Tax rate = 34%

After tax cost of current debt =

= Before tax cost of debt ( 1 - tax rate )

= 7.75% ( 1 - 34% )

= 7.75% ( 1- 0.34 )

= 7.75% ( 0.66 )

= 5.115%

After tax cost of debt is 5.115% or 5.12% ( approx )