Venus Limited has market value of debt of $80 million, market value of equity of $140 million, and cash of $20 million. The pre-tax cost of debt is 10%, the cost of equity is 14%, and the tax rate is 30%. The after-tax cost of debt is …………

Question

BlackTom AI · Accepted Answer

The question provides the components needed to compute the after-tax cost of debt. 
First, identify the given pretax cost of debt: 10%. The tax rate is 30%, so the after-tax cost of debt is adjusted by (1 - tax rate). 
Compute: 10% × (1 - 0.30) = 10% × 0.70 = 7%. 
Now evaluate each option:
- 14.00%: This matches the cost of equity, not the debt. It would be used in calculating the weighted average cost of capital for equity, but it is not the debt cost.
- 30.00%: This equals the tax rate, not the after-tax cost. It does not reflect the interest deduction effect on debt costs.
- 10.00%: This is the pre-tax cost of debt. It ignores the tax shield that lowers the effective cost after taxes.
- 7.00%: This is the after-tax cost of debt, derived from applying the tax shield to the pretax cost, and it is the correct value.
In summary, applying the tax adjustment to the stated pretax cost of debt yields 7.00%, which aligns with the standard formula for after-tax debt cost: Cost After Tax = Cost Before Tax × (1 − Tax Rate).

BFIL001 Week 7 Practice Quiz

Venus Limited has market value of debt of $80 million, market value of equity of $140 million, and cash of $20 million. The pre-tax cost of debt is 10%, the cost of equity is 14%, and the tax rate is 30%. The after-tax cost of debt is …………

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