Cost of Debt Calculation for Honeywell

What is Honeywell's effective cost of debt?

How can the effective cost of debt for Honeywell be calculated?

Answer:

Honeywell's effective cost of debt is 3.78%.

Honeywell's effective cost of debt can be calculated using the after-tax cost of debt formula. The after-tax cost of debt accounts for both the interest tax shield due to deductibility of interest expenses for the corporation and the personal taxes on the bondholder's interest income.

To calculate the after-tax cost of debt, we need to consider three components: the pre-tax cost of debt (the demanded return for debt investors, which is 3.9% in this case), the corporate tax rate (39%), and the average personal tax rate (20%).

1. Calculate the tax shield effect:

Interest tax shield = Pre-tax cost of debt × Corporate tax rate

Interest tax shield = 3.9% × 39% = 1.521%

2. Calculate the after-tax cost of debt:

After-tax cost of debt = Pre-tax cost of debt - Interest tax shield × (1 - Personal tax rate)

After-tax cost of debt = 3.9% - 1.521% × (1 - 20%) = 3.9% - 1.521% × 0.8 = 3.7768%

Therefore, Honeywell's effective cost of debt is approximately 3.78%.