Question

TC, Inc. has $15 million of outstanding bonds with a coupon rate of 10 percent. The yield to maturity on these bonds is 12.5 percent. If the firm's tax rate is 30 percent, what is relevant cost of debt financing to TC, Inc.?A) 13.75 percentB) 8.75 percentC) 7.00 percentD) 3.75 percent

Answer 1

relevant cost of debt financing to TC, Inc.= 8.75%

Step-by-step explanation:

The yield to maturity is a proxy for a company's cost of capital as it reflects the return that a company provides to its debtholders. Given a yield to maturity equal to 12.5% and a tax rateof 30%, the after tax cost of debt is calculated as :

After tax cost of debt =
`kd*(1-t) = 0.125*(1-0.3)=0.0875`

The relevant interest rate is thus equal to 8.75% due to the fact that interest is tax deductible.