Question

Johnson and Johnson is trying to determine the cost of debt for a new capital budgeting project. Currently, Johnson and Johnson has a AAA credit rating from Moody’s. An analyst for Johnson decides to look at the AAA yield curve to determine the cost of debt. The project is expected to last for 10 years, so the analyst wants to find the yield to maturity for 10-year AAA bonds. The marginal tax rate for Johnson is 33.00%.

TIME UNTIL MATURITY YIELD TO MATURITY

1 years 4.48%

5 years 4.98%

10 years 5.23%

15 years 5.48%

Based on the yield curve, what is the cost of debt for the new project?

Answer 1

As project is for 10 years,

So,

Before-tax cost of debt = 5.23%

Tax Rate = 33.00%

After-tax cost of debt = (1 - 0.33)(0.0523)

After-tax cost of Debt = 3.50%