Question

All else constant, which of the following will increase the aftertax cost of debt for a firm? I. increase in the yield to maturity of the firm's outstanding debt II. decrease in the yield to maturity of the firm's outstanding debt III. increase in the firm's tax rate IV. decrease in the firm's tax rate

Answer 1

Answer:

Option A. Increase in the yield to maturity of the firm's outstanding debt

&

Option D. Decrease in the firm's tax rate

Explanation:

The reason is that the increase in yield will result in increase in investor's required return which will increase the after tax cost of debt. Similarly the decrease in tax will also increase the cost of debt to the company because the (1-tax rate) factor is always used in calculating the cost of debt to company.