Question

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 40%, what is Holmes' after-tax cost of debt

Answer 1

Answer:

The correct answer is 6.84%.

Explanation:

According to the scenario, the given data are as follows:

Coupon = 10%

yield to maturity = 14%

Marginal Tax rate = 40%

Here, Issue new bond at par show that YTM = Coupon rate

So, we can calculate the after tax cost of debt by using following formula:

After tax cost of debt = YTM × ( 1 - marginal tax rate )

By putting the value, we get

After tax cost of debt = 0.14 × ( 1 - 0.40)

= 0.14 × 0.60

= 0.684

= 6.84%