Cost of debt

QBank #2409 A company has \$5 million in debt outstanding with a coupon rate of 12 percent. Currently the YTM on these bonds is 14 percent. If the tax rate is 40 percent, what is the after tax cost of debt? A) 5.6%. B) 4.8%. C) 7.2%. D) 8.4%. Your answer: C was incorrect. The correct answer was D) 8.4%. (0.14)(1 - 0.4) _______ I thought after tax cost of debt was calculated from the market rate in force at the time of issue, rather than the current YTM? Am I talking nonsense or does the question lack enough detail?

You always use the YTM. Edit: I should also add that the YTM is effectively the “market price” of the bond. So that’s why you use it, rather than coupon rate.

chrismaths Wrote: ------------------------------------------------------- > QBank #2409 > > A company has \$5 million in debt outstanding with > a coupon rate of 12 percent. Currently the YTM on > these bonds is 14 percent. If the tax rate is 40 > percent, what is the after tax cost of debt? > A) 5.6%. > B) 4.8%. > C) 7.2%. > D) 8.4%. > > Your answer: C was incorrect. The correct answer > was D) 8.4%. > > (0.14)(1 - 0.4) > _______ > > I thought after tax cost of debt was calculated > from the market rate in force at the time of > issue, rather than the current YTM? > > Am I talking nonsense or does the question lack > enough detail? -you’re right it should’ve been the market rate at the time of issuance, which would be used to calculate the interest expense, which is essentially the cost of this outstanding debt issue, but it’s still not the coupon rate, coupon rate is not the market rate, it’s the payment you’re making to your debt holder…also, you’re probably more prudent to use the current market rate since it probably has changed since when you first issued your debt, so to reflect the real cost of this debt, using hte current market rate would be appropriate

The concept is different than presented here . As someone already mentioned on one of the threads cost of capital is looking forward. That idea is stated even in the books (Ihave Schweser) .You have to consider the rate at which you would be able to attract new capital by issuing debt so you use the market rate, which is 14% out of which you substract tax. The rate of interest at which you present debt on a balance sheet I feel is a different thing, the market rate at the issuance of debt