Calculating Interest, Tax Savings, and After-Tax Cost of Debt for Your Firm
How much interest must your firm pay? How much does your firm save in taxes since interest is tax deductible? What is the aftertax cost of debt?
The firm must pay $114,000 in interest. With a tax rate of 35%, the firm saves $39,900 in taxes. The after-tax cost of debt for the firm is 6.175%.
Understanding Interest Payment Calculation
Interest Payment: Your firm has an EBIT of $300,000. The cost of equity is 12.19%, the yield on bonds is 9.50%, and the coupon rate on bonds is 8.50%. You also have $1,200,000 of debt. To calculate the interest payment, we need to multiply the total amount of debt by the yield on bonds: $1,200,000 x 9.5% = $114,000.
Calculating Tax Savings from Interest Deductibility
Tax Savings: Since interest is tax deductible, your firm saves money on taxes. To find out how much your firm saves, we multiply the interest payment by the corporate tax rate: $114,000 x 35% = $39,900.
Determining After-Tax Cost of Debt
After-Tax Cost of Debt: The after-tax cost of debt takes into account the tax savings from interest deductibility. It is calculated by subtracting the tax savings from the cost of debt. In this case, the after-tax cost of debt for your firm is 6.175%, which is lower than the initial cost of debt due to the tax benefits.
These calculations help your firm understand the financial implications of debt financing and the tax advantages of interest deductibility.