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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

AFTER-TAX COST OF DEBT The Holmes Company’s currently outstanding bonds have an 8% coupon and a 10% yield to maturity. Holmes believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 40%, what is Holmes’ after-tax cost of debt?

Summary Introduction

To identify: The after-tax cost of debt.

Introduction:

After-Tax Cost of Debt:

It can be defined as relevant cost of the new debt by considering the tax deductibility in interest. It is the cost of debt after tax savings. The interest on the debt is tax deductible. The tax can be saved on the interest paid on the debt. It is used to compute the weighted average cost of capital.

Explanation

Given information:

Before-tax cost of debt is 10% or 0.10.

Tax rate is 40% or 0.40.

The formula to calculate after-tax cost of debt is,

After-tax cost of debt=rd(1t)

Where,

  • rd is the interest on new debt.
  • t is the tax rate.

Substitute 0

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