If the after-tax cost of debt is 4.2% and the tax rate is 30%, what was the pre-tax cost of debt?

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Multiple Choice

If the after-tax cost of debt is 4.2% and the tax rate is 30%, what was the pre-tax cost of debt?

Explanation:
Interest on debt is tax-deductible, so the after-tax cost is the pre-tax cost reduced by the tax shield: after-tax cost = pre-tax cost × (1 − tax rate). With a 30% tax rate, that multiplier is 0.70. So 4.2% = pre-tax cost × 0.70. Solving gives pre-tax cost = 4.2% / 0.70 = 6%. Therefore, the pre-tax cost of debt is 6%.

Interest on debt is tax-deductible, so the after-tax cost is the pre-tax cost reduced by the tax shield: after-tax cost = pre-tax cost × (1 − tax rate). With a 30% tax rate, that multiplier is 0.70. So 4.2% = pre-tax cost × 0.70. Solving gives pre-tax cost = 4.2% / 0.70 = 6%. Therefore, the pre-tax cost of debt is 6%.

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