Question

For which capital component must you make a tax adjustment when calculating a firm’s weighted average cost of capital (WACC)? Equity Preferred stock Debt Water and Power Company (WPC) can borrow funds at an interest rate of 10.20% for a period of seven years. Its marginal federal-plus-state tax rate is 25%. WPC’s after-tax cost of debt is (rounded to two decimal places). At the present time, Water and Power Company (WPC) has 5-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,050.76 per bond, carry a coupon rate of 10%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 25%. If WPC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? (Note: Round your YTM rate to two decimal place.) 6.53% 7.51% 5.22% 7.84%

Answer 1

Debt

7.65%

6.53%

Step-by-step explanation:

The debt finance has its capital component adjusted for tax when computing weighted average cost of capital.

The after tax cost of borrowing =pretax cost of debt*(1-t)

t is the tax rate of 25% or 0.25

The after tax cost of borrowing =10.20%*(1-0.25)=7.65%

The pretax cost of bond=rate(nper,pmt,-pv,fv)

nper is the duration of bond which is 5 years

pmt is the annual interest=$1000*10%=$100

pv is the current price of $1,050.76

fv is the face value of $1000

=rate(5,100,-1050.76,1000)=8.70%

After tax cost of bond=8.70% *(1-0.25)=6.53%