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ACCA Applied Skills · Financial Management · Sources of finance and their relative costs

Zeta Co has irredeemable 8% loan notes with a nominal value of $100 each, currently trading at $80 ex-interest. The corporation tax rate is 25%. What is the post-tax cost of debt for Zeta Co?

The post-tax cost of irredeemable debt is annual interest after tax divided by market price. Interest of $8 less 25% tax is $6, divided by $80 gives 7.5%.

  1. A7.5%
  2. B10.0%
  3. C6.0%Correct
  4. D8.0%

Explanation

For irredeemable debt, post-tax Kd = I(1-t)/P0 = 8 x 0.75 / 80 = 6/80 = 7.5%. Wait: 6/80 = 0.075, so the result is 7.5%. The option 10.0% ignores tax (8/80), and 6.0% wrongly divides by the nominal value of 100 after tax.

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