Cost of Debt 1 Suppose you are trying to estimate the after

Cost of Debt 1

Suppose you are trying to estimate the after tax cost of debt for a firm as part of the calculation of the Weighted Average Cost of Capital (WACC). The corporate tax rate for this firm is 37%. The firm\'s bonds pay interest semiannually with a 5.2% coupon rate and have a maturity of 9 years. If the annual yield to maturity of the bonds is 8.65%, what is the after tax cost of debt for this firm?

The correct answer is 5.45. Show step by step how I arrive at this answer.

Solution

Calculation of After tax Cost of Debt:

Formula :

After tax Cost of debt = Annual yield to maturity of the bonds * (1-tax rate)

= 8.65% * (1-37%)

= 8.65% * 0.63

= 5.4495 %

= 5.45%