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 25%, what is Holmes' after-tax cost of debt? Round your answer to two decimal places.
Solution :
The formula for calculating the After tax cost of debt is
After tax cost of debt = Kd * ( 1 - t )
Where
Kd = Pre tax cost of debt = Yield to maturity of the bond ; t = Marginal tax rate ;
As per the information given in the question we have
Kd = 14 % = 0.14 ; t = 25 % = 0.25 ;
= 0.14 * ( 1 - 0.25 )
= 0.14 * 0.75
= 0.1050
= 10.50 % ( when rounded off to two decimal places )
Thus Holmes’ after tax cost of debt = 10.50 %
SOLUTION :
After tax cost of debt, rD :
= Pre tax cost of debt * ( 1 - Tax rate in decimals)
= Yield to maturity in percentage * ( 1 - Tax rate in decimals)
= 14 * ( 1 - 0.25)
= 10.50 % (ANSWER)
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