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Question:
A firm has one actively traded bond issue outstanding, with a 6% coupon and a yield to maturity of 5%. When estimating the firm's weighted average cost of capital (WACC), the appropriate after-tax cost of debt capital should most likely be:
A
less than 5%.
explanation
Yield to maturity is an appropriate estimate of a firm's before-tax cost of capital. Its after-tax cost of capital may be estimated as YTM x (1 – tax rate) and will be less than the before-tax cost of capital, as long as the firm faces a positive tax rate, which is the most likely case.
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