Question

​Laurel, Inc., has debt outstanding with a coupon rate of 5.9% and a yield to maturity of 7.2%. Its tax rate is 35%.

What is​ Laurel's effective​ (after-tax) cost of​ debt? ​ NOTE: Assume that the debt has annual coupons. ​Note: Assume that the firm will always be able to utilize its full interest tax shield.

Answer 1

Solution:

The formula for calculating the effective​ (after-tax) cost of​ debt with annual coupons is

Effective (after - tax) cost of debt = K_d * ( 1 - t )

Where

K_d = Yield to maturity = Cost of debt ;   t = tax rate ;

As per the information given in the question we have

K_d = 7.2 %    ;     t = 35 % = 0.35    ;

Applying the above information in the formula we have the effective​ (after-tax) cost of​ debt is

= 7.2 * ( 1 - 0.35 )

= 7.2 * 0.65

= 4.68 %

Thus the effective ( after-tax ) cost of debt = 4.68 %