Question

To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000. If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation?

Answer 1

The after-tax cost of debt can be calculated as follows:
After-tax cost of debt = Rd*(1 - tc),
where Rd represents the cost to issue new debt, tc is tax rate.
In our case Rd = 9.25%, tc = 40%, so:
After-tax cost of debt = 9.25%*(1 - 0.4) = 5.55%.