Question 13.2: By using the yield to maturity on DuPont’s debt, we found th...

PLAN

We can use Eq. 13.3 to calculate DuPont’s effective cost of debt

$r_{D} (1-T_{C} )$                     (13.3)

$r_{D}=0.0281$  (pretax  cost  of  debt)

$T_{c}=0.35$    (corporate tax rate)

EXECUTE

DuPont’s effective cost of debt is 0.0281 (1 – 0.35) = 0.01827 = 1.827%

EVALUATE

For every new $1000 it borrows, DuPont would pay its bondholders 0.0281($1000) = $28.10 in interest every year. Because it can deduct that $28.10 in interest from its income, every dollar in interest saves DuPont 35 cents in taxes, so the interest tax deduction reduces the firm’s tax payment to the government by 0.35($28.10) = $9.83. Thus, DuPont’s net cost of debt is the $28.10 it pays minus the $9.83 in reduced tax payments, which is $18.27 per $1000 or 1.827%.