Cost of Debt (Practice Question 2 d)

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    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!

    Avatar of John Moffat
    John Moffat
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    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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