Question

The stock is currently selling for $17.75 per share, and its noncallable $3,319.97 par value, 20-year, 1.70% bonds with semiannual payments are selling for $881.00. the beta is 1.29, the yield on a 6-month treasury bill is 3.50%, and the yield on a 20-year treasury bond is 5.50%. the required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. the firm's tax rate is 40%.refer to exhibit 10.1. what is the best estimate of the after-tax cost of debt?a. 6.07%

Answer 1

Answer:

the after-tax cost of debt is 13.24

Explanation:

The after-tax cost of debt is the initial cost of debt as a result of the incremental income tax rate.

The after-tax cost of debt is dependent on the incremental tax rate of a business. If profits are low, a business would pay low tax rate, which means that the after-tax cost of debt will increase. Also, if the business profits increase, they would pay higher tax rate, so its after-tax cost of debt will decline.

Given that:

Required return (r) = 11.50% = 0.0115

The yield on a 20-year treasury bond (y) = 5.50% = 0.055

beta (b) = 1.29

rs = y + (r -y) x b

after-tax cost of debt = 5.50% + (11.50% - 5.50%) x 1.29

after-tax cost of debt = 13.24%