Question

How did they arrive with the before-tax cost of debt and the after-tax cost of debt in the table located below from the following information. Please show all workings.

The company will contract a new loan in the sum of $2,000,000 that is secured by machinery
and the loan has an interest rate of 6 percent. Healthy Options has also issued 4,000 new bond
issues with an 8 percent coupon, paid semiannually, and which matures in 10 years. The bonds
were sold at par, and incurred floatation cost of 2 percent per issue.

Loan amount	2000000
Interest rate	6%
Par Value	1000
Coupon rate	8%
Time to maturity	10
Payment frequency	2
Bond price	980
YTM	4.15%
No. of bonds	4000
Debt raised	3920000
Market Value of Debt (MVd)	5920000
% Debt	32.49%
Before tax Cost of debt	4.77%
After tax Cost of debt	3.58%

Answer 1

We would first calculate before tax cost of debt which is calculated as weighted average of debt outstanding
		Weights
Loan outstanding	2000000	33.78%	2000000/5920000
Bond outstanding	3920000	66.22%	3920000/5920000
Total value of loan	5920000
Before tax cost of debt
	Weight (a)	Cost of debt (b)	Weighted average costs (a*b)
Loan	33.78%	6%	2.03%
Bond	66.22%	4.15%	2.75%
			4.77%
Thus, before tax cost of debt is 4.77%
The tax rate is not given but they have assumed to be 25%
After tax cost of debt	Cost of debt*(1-tax rate)
After tax cost of debt	4.77%*(1-0.25)
After tax cost of debt	3.58%
Thus, after tax cost of debt is 3.58%