Question

To calculate the after-tax cost of debt, multiply the before-tax cost of debt by Omni Consumer Products Company (OCP) can borrow funds at an interest rate of 7.30% for a period of four years. Its marginal federal-plus-state tax rate is 45%. OCP's after-tax cost of debt is (rounded to two decimal places). At the present time, Omni Consumer Products Company (OCP) has 5-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,438.04 per bond, carry a coupon rate of 14%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 45%. If OCP wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? (Note: Round your YTM rate to two decimal place.) 2.27% 2.04% 2.61% 1.82%

Answer 1

To calculate the after tax cost of debt, multiply the before tax cost of debt by (1 - tax rate)

The after tax cost of debt is computed as follows:

= 7.30% x (1 - 0.45)

= 4.02% Approximately

The after tax cost of debt is computed as follows:

Plug the below variables in the financial calculator as follows:

PV = - 1,438.04

FV = 1,000

N = 5

PMT = 140 (14% x 1,000)

Finally press CPT and then I/Y. It will give I/Y equal to 4.13% Approximately

So, the after tax cost of debt will be as follows:

= 4.13% x (1 - 0.45)

= 2.27% Approximately

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