Question

A company sold at $1000 par value, noncallable bond that now has 20 years to maturity and a 7.45% annual coupon rate that is paid semiannually. The bond sells for $917, and the company's tax rate is 32%. What is the component cost of debt for use in the WAAC calculation?

Answer 1

We will calculate yield to maturity to calculate the cost of debt

Face value = 1000

Coupon rate is 7.45% Paid semiannualy

Interest rate per period is 3.725

When market rate equals coupon rate price is equal to face value

at market rate of 3.725% price is equal to 1000

Now let is calculate price at 4% per period

Value of bond is present value of cash flows

=37.25(PVIFA 4% 40p) + 1000(PVIF 4% 40p)

= 37.25(19.7928) + 1000(0.2083)

= 945.58

Now we calculate price of bond using interpolation

= 3.725% + (1000-917)×(4-3.75)/(1000-945.6) = 4.19%

Annual interest rate is 4.19×2 = 8.38%

Tax rate 32%

After tax cost of debt is 8.38(1-0.32)= 5.6984%