Detailed Answer
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 .
