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Cost of Debt (Practice Question 2 d)

Zzyywzh15y ago
In PQ2d, Kd is calculated from NPV with consideration of 35% tax.
Then, in WACC calculation, there is no deduction of tax benefit for debt capital.

Is this the practical way in this type of questions? Thank you!
John MoffatJohn MoffatAdmin15y ago#1
The cost of debt has been calculated using the after tax interest, and so the tax benefit has already been taken into account.
Therefore it is not taken into account a second time when calculating the WACC.

The answer is the correct way to do it in the exam (although I should not have labelled the cost of debt as Kd because strictly Kd is the return to investors, which is pre-tax).

I guess you are thinking about the formula for WACC on the formula sheet. That formula only works for irredeemable debt - in this case the after tax cost of debt is the pre-tax cost x (1-t). The formula does not work when the debt is redeemable and you must do it the way the answer to that question does.
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