Question

Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 20 years to maturity and a 8.00% annual coupon that is paid semiannually. The bond currently sells for $925 and the company’s tax rate is 25%. What is the component cost of debt for use in the WACC calculation?

Please show all work

Answer 1

Current Price = 925

Coupon 8%

Maturity = 20 years

Let's assume the YTM be 8.5%

Value of Bond =

=

= 952.306813188

Now,

Let's assume the YTM be 9%

Value of Bond =

=

= 907.992077888

YTM = Lower Rate + (\frac{Surplus}{Surplus + deficit}) * (Higher Rate - Lower rate)

= 9% + ((952.306813188 - 925) / (952.306813188 - 925) + (925 - 907.992077888)) * (9-8.5)

= 9% + (27.306813188 / 44.3147353) * 0.5

= 9% + 0.3081

= 9.31%

Cost of Debt after tax = 9.31% (1-0.25)

= 6.9825%