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26 October, 08:30

Omni Consumer Products Company (OCP) can borrow funds at an interest rate of 11.10% for a period of five years. Its marginal federal-plus-state tax rate is 30%. OCP's after-tax cost of debt is (rounded to two decimal places).

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  1. 26 October, 08:54
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    After-tax cost of debt is 7.77%

    Explanation:

    After-tax cost of debt=pre-tax cost of debt * (1-tax rate)

    pretax-cost of debt is 11.10%

    tax rate is 30%

    After-tax cost of debt=11.10% * (1-30%)

    =11.10% * (1-0.3)

    =11.10%*0.7

    =7.77%

    The after-tax cost of debt considers the tax shield opportunity brought about by paying interest on the bond, by tax shield the fact that interest is a deductible expense for tax purposes, the interest expense reduces overall tax liability unlike a situation where no such expense was incurred.
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