Question

Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 8 years to maturity and a 7.80% annual coupon that is paid semiannually. The bond currently sells for $840, and the company’s tax rate is 28%. What is the component cost of debt for use in the WACC calculation? Use Nominal rates. Do not round your intermediate calculations. State in percentage terms without the percent sign symbol and round to the second decimal place.

Answer 1

Face Value = $1,000
Current Price = $840

Annual Coupon Rate = 7.80%
Semiannual Coupon Rate = 3.90%
Semiannual Coupon = 3.90% * $1,000
Semiannual Coupon = $39

Time to Maturity = 8 years
Semiannual Period to Maturity = 16

Let Semiannual YTM be i%

$840 = $39 * PVIFA(i%, 16) + $1,000 * PVIF(i%, 16)

Using financial calculator:
N = 16
PV = -840
PMT = 39
FV = 1000

I = 5.421%

Semiannual YTM = 5.421%
Annual YTM = 2 * 5.421%
Annual YTM = 10.842%

Before-tax Cost of Debt = 10.84%

After-tax Cost of Debt = Before-tax Cost of Debt * (1 - Tax Rate)
After-tax Cost of Debt = 10.84% * (1 - 0.28)
After-tax Cost of Debt = 7.80%