The before tax cost of debt for a firm which has a marginal tax rate of 30% is 12%. Therefore the cost of debt that should be used in calculating the cost of capital for capital budgeting purposes is:

a. 3.6%

b. 6%

c. 8.4%

d. 30%

Option C is correct answer

Explanation:

We have the following details:

Cost of Debt (Kd) = 12%

Tax Rate = 30%

Cost of debt for discounting Capital Project is Post Tax Cost of debt

The reason of this is that the Interest paid on debt is eligible for tax deduction, Hence Post Tax cost of debt will be used for discounting the project cashflows

Discount rate = Cost of Debt * (1 - Tax rate)

= 12% * (1 - 0.30)

= 12% * (0.70)

= 8.4% is the cost of debt that should be used in calculating the cost of capital for capital budgeting purposes.