Question

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 11 years to maturity that is quoted at 100 percent of face value. The issue makes semiannual payments and has an embedded cost of 9 percent annually. The tax rate is 36 percent.

Required:
a. The company's pretax cost of debt is:_______
b. The aftertax cost of debt is:________

Answer 1

Answer: a. 9%

b. 5.76%

Step-by-step explanation:

a. The Pre-tax cost of debt is the interest rate of the debt issue as it is before it is adjusted for tax. That interest rate is 9% and so is the Pre-tax cost of debt.

b. The After tax cost of debt has been adjusted for the tax rate. Interest is tax deductible so the tax rate will be adjusted from the interest rate by;

After tax cost of debt = Pre-tax cost of Debt ( 1 - tax rate)

= 9% * ( 1 - 36%)

After tax cost of debt = 5.76%