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5 July, 13:50

The Heuser Company's currently outstanding bonds have a 10% coupon and a 12% yield to maturity. Heuser believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is Heuser's after-tax cost of debt?

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  1. 5 July, 14:20
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    Answer: After-tax cost of debt is 7.8%.

    Explanation:

    Given that,

    coupon = 10% (outstanding bonds)

    yield to maturity (YTM) = 12%

    marginal tax rate = 35%

    The after-tax cost of debt:

    After-tax cost of debt = YTM (1 - Tax rate)

    = 12% (1 - 0.35)

    = 0.12 (0.65)

    = 0.078

    = 7.8%

    YTM is used in the after-tax calculation because it represents the true pre-tax cost of debt to the issuer.

    Therefore, the after-tax cost of debt is 7.8%
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