Question

The Hype Company's currently outstanding bonds have a 10 percent coupon and a 11 percent yield to maturity. Hype believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 38 percent, what is Hype's after-tax cost of debt

Answer 1

Answer:

After tax cost of debt is 6.82%

Explanation:

Currently the yield to maturity is the  pre-tax cost of debt for Hype company, however the after tax cost of debt considers that the bonds are tax deductible , its actual is less than the pre-tax cost of debt , hence the after-tax cost of debt is shown below

After tax cost of debt=yield to maturity *(1-tax)

after tax cost of debt=11%*(1-0.38)

after tax cost of debt=11%*0.62

after tax cost of debt =6.82%

This confirms that cost of debt is usually lower than cost of equity , where shareholders would want an extra premium to compensate them for the increased risk taken by investing in the business.