Question

The Lincoln Company sold a $1,000 par value, noncallable bond several years ago that now has 30 years to maturity and a 6.00% annual coupon that is paid semiannually. The bond currently sells for $925 and the company's tax rate is 35%. What is the after-tax cost of debt for use in the WACC calculation?

Answer 1

Par Value = $1,000
Current Price = $925

Annual Coupon Rate = 6.00%
Semiannual Coupon Rate = 3.00%
Semiannual Coupon = 3.00%*$1,000
Semiannual Coupon = $30

Time to Maturity = 23 years
Semiannual Period to Maturity = 46

Let semiannual YTM be i%

$925 = $30 * PVIFA(i%, 46) + $1,000 * PVIF(i%, 46)

Using financial calculator:
N = 46
PV = -925
PMT = 30
FV = 1000

I = 3.32%

Semiannual YTM = 3.32%
Annual YTM = 2 * 3.32%
Annual YTM = 6.64%

Before-tax Cost of Debt = 6.64%
After-tax Cost of Debt = 6.64% * (1 - 0.35)
After-tax Cost of Debt = 4.32%