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The 1-year bonds of Casino, Inc., have a 10.9 percent coupon rate and trade in the...

The 1-year bonds of Casino, Inc., have a 10.9 percent coupon rate and trade in the market at a yield of 12.2 percent. There is a 4.4 percent chance that Casino will default and pay nothing. What cost of debt should be used in Casino's WACC? please describe the logic behind the calculation, I am just unsure if yield also reflects the chances of default, please clear out the confusion.

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Answer #1

Dear, the below mentioned points help you to clear your confusion:

  1. While calculating WACC, the post tax cost of debt is being use i.e. post tax coupon rate and not yield rate
  2. Yield rate is being calculate from the perspective of investor of bond and not for issuing co.
  3. For issuing co. Default percentage can not be considered. Because it have an obligation to pay and it becomes liability if not paid
  4. Therefore we can conclude that cost of debt use in casino's WACC is 10.9%. provided no tax is being levied

Note: if you still have any confusion feel free to ask me...

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