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

Question

Harley Mills

Business

22 March, 05:33

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

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Answers (1)

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Johnny · Answer 1

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.