Answer (D) is correct . Because interest is deductible for tax purposes, the actual cost of debt capital is the net effect of the interest payment and the offsetting tax deduction. The actual cost of debt equals the interest rate times (1 – the marginal tax rate). Thus, if a firm with an 8% market rate is in a 40% tax bracket, the net cost of the debt capital is 4.8% [8% × (1.0 – .40)].
Answer (A) is incorrect because The tax deduction always causes the market yield rate to be higher than the cost of debt capital.
Answer (B) is incorrect because Additional debt may or may not be issued more cheaply than earlier debt, depending upon the interest rates in the market place.
Answer (C) is incorrect because The cost of debt is less than the yield rate given that bond interest is tax deductible.
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