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**CFA Practice Question**

Consider the following characteristics of a firm:

Annual dividend: $1

Debt rate: 12%

Equity floatation cost: 5%

Tax rate: 40%

Preferred stock par value: $100

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%.

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**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 :) |