Question

LL Incorporated's currently outstanding 9 percent coupon bonds have a yield to maturity of 6 percent. LL believes it could sell new bonds that would provide a similar yield to maturity. If its marginal tax rate is 34 percent, what is LL's after-tax cost of debt? Express your answer in percentage (without the % sign) and round it to two decimal places.

Answer 1

The after-tax cost of debt for LL Incorporated is calculated using the yield to maturity of their bonds and their marginal tax rate. It comes out to be 3.96% after applying the formula which incorporates the 34 percent tax rate.

Step-by-step explanation:

To calculate the after-tax cost of debt for LL Incorporated, we use the yield to maturity (YTM) as the pre-tax cost of debt and adjust for the company's marginal tax rate. LL's currently outstanding bonds have a YTM of 6 percent, which serves as the pre-tax cost of debt.

The formula to determine the after-tax cost of debt is:

After-tax cost of debt = Pre-tax cost of debt × (1 - Tax rate)

We can plug in the values we have:

After-tax cost of debt = 0.06 × (1 - 0.34)

The calculation will give us:

After-tax cost of debt = 0.06 × 0.66 = 0.0396 or 3.96%

Therefore, the after-tax cost of debt for LL Incorporated would be 3.96%, rounded to two decimal places.