Question

3. An overview of a firm's cost of debt

The   is the interest rate that a firm pays on any new debt financing.

Water and Power Company (WPC) can borrow funds at an interest rate of 10.20% for a period of eight years. Its marginal federal-plus-state tax rate is 40%. WPC’s after-tax cost of debt is     (rounded to two decimal places).

At the present time, Water and Power Company (WPC) has 15-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,555.38 per bond, carry a coupon rate of 11%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 40%. If WPC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)?

3.29%

3.78%

3.95%

2.96%

Answer 1

a)

After-tax cost of debt:

= 10.20%*(1-40%)

= 6.12%

b)