Question

Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 15 years to maturity and a 6.00% annual coupon that is paid semiannually. The bond currently sells for $1,200, and the company’s tax rate is 20%. 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. (Thus, 12.98756% would be written as 12.99 to be correct)

Answer 1

Sol:

Par value (FV) = $1000

Present value (PV) = $1200

Maturity period (nper) = 15 years, Semiannual = 15 x 2 = 30

Coupon rate = 6% Annually, Semiannually = 6%/2 = 3%

PMT = Semiannual coupon rate = 1000 x 3% = $30

Tax rate = 20%

To compute component cost of debt for use in the WACC calculation:

First we need to compute Interest rate by using RATE function in Excel:

FV	1000
PV	-1200
nper	30
PMT	30
Rate	2.10

So cost of debt before tax will be (Rate x 2) = (2.10 x 2) = 4.10

Cost of debit after tax = Cost of debit x ( 1 - tax rate )

Cost of debit = 4.10 x ( 1 - 0.20 )

Cost of debit is 4.10 x 0.80 = 3.28

Therefore component cost of debt for use in the WACC is 3.28

Rate computation working