Question

Several years ago the Jakob Company sold a $1,000 par value, 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?
A. 4.28%
B. 4.46%
C. 4.65%
D. 4.83%
E. 5.03%

Answer 1

Answer :

cost of debit is 4.64 %

Explanation:

given data  

sold = $1,000

time t = 20 year  

rate r = 7 %  

bond currently sells = $925

tax rate = 40%

 

to find out  

component cost

solution

we will find first YTM by given formula that is  

bond currently sells = $\sum_{1}^{2t}$ ( semi annual coupon / $(1+YTM/2)^{t}$ ) + sold / (1+YTM/2)^{2t}[/tex] )

put here all value

so we get  

925 = $\sum_{1}^{40}$ ( (1000×7/100×7) / $(1+YTM/2)^{20}$ ) + sold / (1+YTM/2)^{40}[/tex] )

so here solve and we get  

YTM = 3.87 %

and

cost of debit = 3.87 % × 2 = 7.74%

we know that cost of debit after tax is equal  cost of debit ( 1 - tax rate )

put here value

cost of debit = cost of debit ( 1 - tax rate )

cost of debit = 7.74% ( 1 - 40% )  

cost of debit is 4.64 %