Corporate Finance Q91

91A company issued $20 million in long-term bonds at par value three years ago with a coupon rate of 10 percent. The company has decided to issue an additional $20 million in bonds and expects the new issue to be priced at par value with a coupon rate of 8 percent. There is no other outstanding debt. The applicable tax rate is 35 percent. The appropriate after-tax cost of debt in order the compute the weighted average cost of capital is closest to:

Option : A
Explanation : The appropriate cost is the marginal cost of debt. The before-tax cost of debt can be calculated by the yield to maturity on a comparable outstanding. After adjusting for tax, the after-tax cost of debt is 8(1 – 0.35) = 8(0.65) = 5.2%.

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