Question

Several years ago the Jakob Company sold a $1,000 par value, a noncallable bond that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually.  The bond currently sells for $925, and the company's tax rate is 40%.  What is the component cost of debt for use in the WACC calculation?

Answer 1

Calculate the semi-annual Yield to Maturity (YTM) for bonds using MS-EXCEL “RATE" Function as follows: Function Arguments RATE Nper 20 2 Pmt -1000"7%/2 35 Pv 925 925 1000 number Fv -1000 Type -0.038717234 Returns the interest rate per period of a loan or an investment. For example, use 6%/4 for quarterly payments at 6% APR. Nper is the total number of payment periods for the loan or investment. Formula result = 3.87% Help on this function OK Cancel The semi-annual Yield to Maturity (YTM) of bond is 3.87% Calculate the after tax annual YTM or cost of debt as follows: After tax annual cost of debt- (Cost of debtx2)x (1-Tax rate) (3.87% x 2)x(1-40%) 7.74% x 60% -14.64% Therefore, after-tax annual cost of debt is 4.64%