Question

Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually. The bond currently sells for $1015, and the company’s tax rate is 40%. What is the component cost of debt for use in the WACC calculation? Round to 2 decimal places.

Answer 1

Coupon rate = 7% face value = 1000

N is 20 years price of bond is 1015

We have to find yeild to maturity on the bond to calculate cost of debt

Value of bond at 7% yeild is 1000(as when yeild equals coupon rate price equals face value)

Now value of bond at 6% yeild

Value of bond is present value of all cash flows

= 35(PVIFA 3% 40p) + 1000(PVIF 3% 40p)

= 35(23.1148) + 1000(0.3066)

= 1115.62

Now we use interpolation method to calculate yeild

= 6% + (1115.62-1015)/(1115.62-1000)

= 6.87%

Cost of debt is 6.87%

Tax rate is 40%

After tax cost of debt = kd(1-t)

= 6.87(1-0.4) = 4.122