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# After tax cost of debt, cost of equity

1. The Heuser Company's currently outstanding 10 percent coupon bonds have a yield to maturity of 12 percent. Heuser believes it could issue at par new bonds that would provide a similar yield to maturity. If its marginal tax rate is 35 percent, what is Heuser's after tax cost of debt?

2. The earnings, dividends, and stock price of Carpetto Technologies Inc. are expected to grow at 7 percent per year in the future. Carpetto's common stock sells for \$23 per share, its last dividend was \$2.00, and the company will pay a dividend of \$ 2.14 at the end of the current year.

a. using the discounted cash flow approach, what is it's cost of equity?

b. If the firms beta is 1.6, the risk free rate is 9%, and the expected return on the market is 13%, what will be the firms cost of equity using the CAPM approach?

c. If the firms bonds earn a return of 12%, what will rs be using the bond yield-plus-risk-premium approach?

d. On the basis of the results of parts a through c, what would you estimate Carpetto's cost of equity to be?

#### Solution Preview

1. The Heuser Company's currently outstanding 10 percent coupon bonds have a yield to maturity of 12 percent. Heuser believes it could issue at par new bonds that would provide a similar yield to maturity. If its marginal tax rate is 35 percent, what is Heuser's after tax cost of debt?

Calculate the after tax cost of debt

Marginal Tax rate T = 35%
Pre tax cost of debt= kd= 12.00% (Yield to maturity)
After tax cost of debt= kd(1-T)= 7.800% =(100% -35.%)*12.%