Question

Intro Simple Corp. has one bond issue oustanding, with a maturity of 10.5 years, a coupon rate of 3.5% and a yield to maturity of 5.5%. Simple Corp.'s average tax rate is 18% and its marginal tax rate is 30%. What is the (pre-tax) cost of debt? What is the after-tax cost of debt?

Answer 1

The (pre-tax) cost of debt for Simple Corp is 2.87% and the after-tax cost of debt is 2.45%

Step-by-step explanation:

The (pre-tax) cost of debt can be calculated using the formula:

(Coupon Rate) x (1 - Average Tax Rate)

In this case, the coupon rate is 3.5% and the average tax rate is 18%. So the pre-tax cost of debt for Simple Corp is:

3.5% x (1 - 18%) = 2.87%

The after-tax cost of debt can be calculated using the formula:

(Coupon Rate) x (1 - Marginal Tax Rate)

In this case, the coupon rate is 3.5% and the marginal tax rate is 30%. So the after-tax cost of debt for Simple Corp is:

3.5% x (1 - 30%) = 2.45%