Calculate the cost of debt for the following firm:
Borrowing Rate 10%
Marginal Tax Rate 40%
Project IRR 12.5%
Owner's Equity 15%
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A. B. C. D. E.B
The cost of debt is simply the rate of borrowing less the tax savings. Due to the fact that interest expense is tax deductible, the cost of debt in this case is 10%(1 -
.4) = 10%(.6) = 6%.
To calculate the cost of debt for the given firm, we need to use the after-tax cost of debt formula. The formula is as follows:
Cost of Debt = Borrowing Rate * (1 - Marginal Tax Rate)
Given: Borrowing Rate = 10% Marginal Tax Rate = 40%
Plugging in the values into the formula:
Cost of Debt = 10% * (1 - 40%) Cost of Debt = 10% * (0.6) Cost of Debt = 6%
Therefore, the cost of debt for the firm is 6%.
The correct answer is B. 6%.