Question

Item Value Debt Capital $80,000 Income before interest and tax $50,000 Interest on debt capital 5% Tax rate 40% What is the net savings on the interest calculated after tax? The after-tax cost of debt capital is percent.

Answer 1

To calculate the net savings on interest after tax for a debt capital of $80,000 and a 5% interest rate, we find the interest amount ($4,000), determine the tax savings ($1,600), and subtract it from the interest paid. The net savings is $2,400, leading to an after-tax cost of debt capital of 3%.

Step-by-step explanation:

The student is asking how to calculate the net savings on interest after tax considering a debt capital of $80,000, an income before interest and taxes of $50,000, an interest rate on debt capital of 5%, and a tax rate of 40%.

To compute the net savings, we first need to determine the amount of interest paid on the debt capital, which is $80,000 multiplied by 5%, giving us $4,000. Next, the tax savings on this interest can be calculated by applying the tax rate of 40% to the $4,000 of interest paid, resulting in $1,600. However, this is not the net savings; it's the amount saved in taxes due to the interest expense deduction.

The actual net savings would be the interest paid minus the tax savings, which is $4,000 - $1,600 = $2,400. Consequently, the after-tax cost of debt is the interest cost less the tax savings, which in percentage terms can be calculated as ($2,400/$80,000) * 100, equating to 3%. So, the after-tax cost of debt capital is 3%.