Question

Spanolia LLC is estimating its WACC. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for 1,000 USD. The firm's marginal tax rate is 40 percent. What is the after-tax cost of debt? Answer in % terms to 2 decimal places w/o the % sign.

Answer 1

Spanolia LLC

The after-tax cost of debt is:

= 7.20%.

Step-by-step explanation:

a) Data and Calculations:

Coupon interest rate of bonds = 12%

Maturity period = 20 years

Selling price = $1,000

Firm's marginal tax rate = 40%

After-tax cost of debt = Coupon interest rate * (1 - tax rate)

= 12% * (1 - 0.4)

= 12% * 0.6

= 7.20%

b) Spanolia's after-tax cost of debt is derived by multiplying the cost of debt by the after-tax rate. The after-tax cost of debt represents the interest that Spanolia LLC pays on the bonds less the income tax savings that it gains because interest expenses are tax-deductible.