Question

drop down option 1: (1-T) or (1+T)

To calculate the after-tax cost of debt, multiply the before-tax cost of debt by Three Waters Company (TWC) can borrow funds at an interest rate of 12.50% for a period of seven years. Its marginal federal-plus-state tax rate is 45%. TWC's after-tax cost of debt is (rounded to two decimal places). At the present time, Three Waters Company (TWC) has 5-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have current market price of $1,050.76 per bond, carry a coupon rate of 10%, and distribute annual coupon payments. The company incurs a federal-plus- state tax rate of 45%. If TWC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? O 4.31% 4.79% 5.75% O 3.83%

drop down option 2: 7.91%, 12.50%, 5.85%, 6.88%

Answer 1

1. Ans. (1-T)

Reason. After tax cost is calculated by subtracting the tax benefit from the cost accounted. So, if we multiply Cost with (1-T) it will give the cost less tax benefit.

2. Ans. 6.88%

Calculation. After Tax cost = Before tax cost (1-Tax rate)

= 12.5% (1 - 55% )

= 6.875

3. Calculation of IRR

Year	Cash Flow	PVF@10%	PV@10%	PVF@8%	PV@8%
1	100	0.909091	90.90909	0.925926	92.59259
2	100	0.826446	82.64463	0.857339	85.73388
3	100	0.751315	75.13148	0.793832	79.38322
4	100	0.683013	68.30135	0.73503	73.50299
5	1100	0.620921	683.0135	0.680583	748.6415
			1000		1079.854
	Present Value		1050.76		1050.76
	NPV		50.76		-29.0942

IRR = 8% + {29.0942/(50.76+29.0942)}*2

= 8.73% approx

After tax cost of debt = 8.73% (1-45%)

= 4.79 (approx)