The aftertax cost of debt: Group of answer choices Varies inversely to changes in market interest rates. Will generally exceed the cost of equity if the relevant tax rate is zero. Will generally equal the cost of preferred if the tax rate is zero. Is unaffected by changes in the market rate of interest. Is highly dependent upon the firm's tax rate.

The after-tax cost of debt is the net cost of the debt that is determined by the adjustment of the gross cost of the debt for the tax benefits. This is given by the formula:

[tex]The after-tax cost of debt = pre-tax cost of debt (1 - tax rate)[/tex]

For example, a business with outstanding loan with interest rate of 15 %. The business has the incremental rate of 25 % federal taxes and 5 % for state taxes. The after-tax will be

15 % before tax cost × (100 - 30 incremental rate)

= 10.5 % after tax cost of debt

In essence, the after-tax cost of debt is the cost of debt that is included in the calculation of the average cost of capital.

The cost of the new debt after incorporating the after-tax cost of debt is important in the capital budgeting decisions.