Galena Corporation has a tax rate of 30%. Today they issued bonds with a face value of $1,000 for a price of $926.40. They have a 10-year maturity and a 5% coupon. What is Galena’s after-tax cost of debt?
A. 6%
B. 5%
C. 3.5%
D. 4.2%
Galena Corporation's after-tax cost of debt is approximately 3.63%. The correct option is: C. 3.5%.
Calculation of Galena Corporation’s After-Tax Cost of Debt
Interest Expense:
The coupon rate is 5% of the face value, which is $1,000 * 0.05 = $50 per year.
Tax Shield:
The tax shield is the interest expense multiplied by the tax rate. In this case, it is $50 * 0.30 = $15 per year.
After-Tax Cost of Debt:
To calculate the after-tax cost of debt, we subtract the tax shield from the coupon rate and divide by the bond price.
After-tax cost of debt = (Coupon rate - Tax shield) / Bond price
After-tax cost of debt = ($50 - $15) / $926.40
After-tax cost of debt ≈ 0.0363 or 3.63%
Therefore, Galena Corporation's after-tax cost of debt is approximately 3.63%.