Respuesta :
After-tax cost of debt is 8.06%
What Is the Cost of Debt?
The cost of debt is the actual interest rate that a company pays on its debts, including bonds and loans. Either the before-tax cost of debt, which is the amount owing by the business before taxes, or the after-tax cost of debt may be used to indicate the cost of debt. The majority of the difference between the cost of debt before and after taxes can be attributed to the fact that interest expenses are tax deductible.
The cost of debt is the effective interest rate that a business pays on its debt, such as bonds and loans.
The main distinction between the pretax cost of debt and the after-tax cost of debt is that interest expense is tax deductible.
• The capital structure of a corporation consists of two parts: equity and debt.
The average interest rate paid on all of a company's obligations must be determined in order to calculate the cost of debt.
How the Cost of Debt Works?
A company's capital structure, which also contains equity, includes debt as one component. A company's capital structure describes how it uses a variety of financial sources, including debt in the form of bonds or loans, to fund its overall operations and growth.
Understanding the entire rate that a company pays to use different kinds of debt financing is made easier with the help of the cost of debt measure. Due to the fact that riskier businesses typically have higher loan costs, the metric can also provide investors with a sense of how risky the company is in comparison to others.
Impact of Taxes on Cost of Debt
The interest paid on the debt less any income tax savings from deducting interest payments is the after-tax cost of debt. To determine a company's cost of debt after taxes, divide its effective tax rate by one and multiply the result by the cost of debt. Instead of using the company's marginal tax rate, the effective tax rate is calculated by combining the state and federal tax rates.
A company's pretax cost of debt, for instance, is 5% if all of its debt is represented by bonds it has issued at a 5% interest rate. If the effective tax rate is 30%, the difference between the two is 70%, which is 3.5% of the 5%. The cost of debt after taxes is3.5%
This computation is justified by the tax benefits the corporation experiences by deducting interest as a business expense. 2 Using the previous example as a guide, suppose the business issued $100,000 in bonds at a 5% interest rate. It has a $5,000 yearly interest payment. It declares this sum as an expense, which reduces the business's revenue by $5,000. The corporation writes off its interest, which results in a $1,500 tax savings because it pays a 30% tax rate. As a result, the business only effectively settles its debt for $3,500. This amounts to an interest rate on its debt of 3.5 percent.
BREFING:
The initial cost of debt is the after-tax cost of debt, which has been modified to account for the impact of the marginal income tax rate. It is calculated by deducting the company's incremental tax rate from 100 percent and multiplying the result by the debt's interest rate. The equation is:
Before-tax cost of debt x (100% - incremental tax rate)
= After-tax cost of debt
SOLUTION OF QUESTION=
13%*(100%-38%)=8.06%
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