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31 January, 10:03

The Holmes Company's currently outstanding bonds have a 10% coupon and a 14% yield to maturity. Holmes believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 40%, what is Holmes' after-tax cost of debt

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  1. 31 January, 10:12
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    The correct answer is 6.84%.

    Explanation:

    According to the scenario, the given data are as follows:

    Coupon = 10%

    yield to maturity = 14%

    Marginal Tax rate = 40%

    Here, Issue new bond at par show that YTM = Coupon rate

    So, we can calculate the after tax cost of debt by using following formula:

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

    By putting the value, we get

    After tax cost of debt = 0.14 * (1 - 0.40)

    = 0.14 * 0.60

    = 0.684

    = 6.84%
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