For which capital component must you make a tax adjustment when calculating a firm’s weighted average cost of capital (WACC)?
a. Debt
b. Equity
c. Preferred stock
Omni Consumer Products Company (OCP) can borrow funds at an interest rate of 12.50% for a period of seven years. Its marginal federal-plus-state tax rate is 30%. OCP’s after-tax cost of debt is (rounded to two decimal places).
At the present time, Omni Consumer Products Company (OCP) has 20-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,382.73 per bond, carry a coupon rate of 13%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 30%. If OCP wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? (Note: Round your YTM rate to two decimal place.)

= Weightage of debt × cost of debt × ( 1- tax rate) + (Weightage of preferred stock) × (cost of preferred stock) + (Weightage of common stock) × (cost of common stock)

The computation of the pre-tax cost of debt and after-tax cost of debt is shown below:

1. The after tax cost of debt would be

= Pretax cost of debt × ( 1 - tax rate)

= 12.50% × ( 1 - 0.30)

= 8.75%

The NPER represents the time period.

Given that,

Present value = $1,382.73

Assuming figure - Future value or Face value = $1,000

PMT = 1,000 × 13% = $130

NPER = 20 years

The formula is shown below:

= Rate(NPER;PMT;-PV;FV;type)

The present value come in negative

So, after solving this,

3. The pretax cost of debt is 8.85%

4. And, the after tax cost of debt would be

= Pretax cost of debt × ( 1 - tax rate)

= 8.85% × ( 1 - 0.30)

= 6.195%