CFA Practice Question

CFA Practice Question

Consider the following characteristics of a firm:

Stock price: $60
Annual dividend: $1
Debt rate: 12%
Equity floatation cost: 5%
Tax rate: 40%
Preferred stock par value: $100

What is the firm's after-tax cost of debt?
A. 5%
B. 7.2%
C. 12%
Explanation: A firm's after-tax cost of debt may be calculated using the following formula: After-Tax Cost of Debt = Cost of Debt x (1 - Tax Rate). In this case, the after-tax cost of debt = 12% x (1 - 40%) = 12% x 60% = 7.2%.

User Contributed Comments 12

User Comment
julamo this question is far below the average level of this mock exam, it's like some fresh air in hell!
ontrack and i thought there's some other formula involved that i dont know so did not select C!!
Hope02 This question scared the hell out of me for nothing. Nevertheless, I took good note as some answers to questions are right to our nose.
twotwo why give the extra information not needed!!!
julescruis I went crazy on this one: I tried to derive the cost of capital using CAPM and DDM. This reminds me to be thourough in the reading of the questions
sagania I couldnt believe it could be that simple... Of course I guessed then, and guesses wrong!
scotty21 I was dominated by this question also franticly trying to figure out how to apply the CAPM without knowing the debt/equity ratio... Must READ the question. Cost of DEBT!
JepTang Intuitively, given the answer choices, one could immediately determine that the answer would be B. 50% of 12% would be 6%, thus A should immediately be scratched out.
12% would not be realistic as cost of debt is tax deductible, this leaves us with B which is a little higher than 6%.
Yohan3109 Just always remeber the real cost of debt after tax rate (1-tx)*debt rate. no need to derivate nothing. read carrefuly the question CFA exam is 240 questions just few of them will invole big calculation...
mekc determine question first, info second, saves time and avoids confusion
ColonelCFA I was trying to figure out how I could make this a WACC questions!
farhan92 good point yohan.. think it is worth taking a step back to understand what the question is asking before going crazy with the calculator.

Bringing some eco theory into it the marginal cost of spending 5 minutes on a calculation is far greater than the marginal benefit :)
You need to log in first to add your comment.