Outstanding debt of Home Depot trades with a yield to maturity of 5%. The tax rate of Home Depot is 35%. What is the effective cost of debt of Home Depot?

the effective cost of debt of Home Depot is 3.25 %.

Explanation:

Effective Cost of debt is the cost of debt after the tax shield.

In terms of the Tax Act, interest expense attract a deduction known as tax shield from income tax and this lowers the cost of debt financing as compared to equity financing.

Effective cost of debt = interest × ( 1 - tax shield)

                                    = 5.00 % × (1 - 0.35)

                                    = 3.25 %

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