CFA Level I · CFA Level I Exam · Capital Structure
A company issues a bond with a pre-tax yield to maturity of 8.0%. The corporate tax rate is 25%, and interest is fully tax deductible. The after-tax cost of debt is closest to:
The after-tax cost of debt is the pre-tax yield times one minus the tax rate: 8.0% × 0.75 equals 6.0%. Interest deductibility lowers the effective cost of borrowing by the tax shield of 2.0 percentage points.
- A2.0%
- B6.0%Correct
- C8.0%
Explanation
After-tax cost of debt = 8.0% × (1 − 0.25) = 6.0%. The 2.0% figure is the tax shield (8.0% × 25%) rather than the after-tax cost. The 8.0% figure ignores the deductibility of interest.
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