Answer:
Before-tax interest rate = 6.738%
After-tax interest rate = 4.7169%
Explanation:
Before we determine before and after tax interest rate per year, we need to understand the tax consequences arising from raising debt finance. Normally debt finance is considered a cheaper source of finance than other long term sources of finance due to two main reasons, 1st, debt providers require greater security (i.e assets being secured/charged) and 2nd, interest on debt is tax-deductible which means companies raising debt finance will benefit by paying lower taxes due to the interest being paid before taxes, hence, reducing the taxable income and tax liability. Therefore, an entity's after-tax interest rate will always be lower than before-tax interest rate. This will be proved as follows:
The formula used to compute before-tax interest rate/cost of debt is as follows;
kd = (i÷ market value of debt)×100
i = yearly interest
yearly interest= 1117.451×12= $13409.412
kd = ($13409.412÷$199000)×100
kd= 6.738%
The formula for after-tax interest rate is same except for the inclusion of tax consequences, as follows:
kd = {i(1-t) ÷ market value of debt} ×100
As we know the after-tax interest is interest paid on debt less any income tax savings due to deductible interest expense, that's why the (1-t).
kd = {$13409.412(1-0.30)÷199000}×100
kd= $9386.588 ÷$199000×100
kd= 4.7169%