LL Incorporated’s currently outstanding 11% coupon bonds have a yield to maturity of 14%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL’s after-tax cost of debt?

The cost of borrowing after tax

LL Incorporated’s after-tax cost of debt is 10.1% (14%-3.9%). To calculate the after-tax cost of debt, we need to subtract LL Incorporated’s tax savings from its current pre-tax yield to maturity. The current coupon rate for LL’s 11% bonds is equal to the pre-tax yield to maturity, which is 14%. Taxes are paid at 35% for the company, and therefore, tax savings equals 35% times 11% or 3.9%. If they were to issue bonds with a yield similar to their current ones (14%), their cost of debt after tax would then be equal 14%-3.9%=10.1%.

When evaluating capital projects and investments, companies can look at the cost after tax of borrowing to see which has a better expected return. This is based on their particular tax situation as well as the costs involved in financing that investment or project. It can be used by companies in conjunction with other factors, such as their liquidity preferences and risk tolerance level when deciding on long-term financial planning.

Additionally, this information can prove useful for investors interested in evaluating certain stocks since knowing a company’s estimated after-tax cost of debt provides insight into how much interest payments might impact future earnings and cash flows – thereby influencing investor expectations about performance over time. Government entities also set benchmarks on corporate borrowing rates to encourage businesses into investing more in capital-intensive projects. This helps stimulate the economy in a particular area, without putting additional pressure on public resources through excessive borrowing.