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?

4.64%

Explanation:

The component cost of debt for use in WACC computation is the after-tax cost of debt

pretax cost of debt=yield to maturity

the yield to maturity can be determined using excel rate formula

=rate(nper,pmt,-pv,fv)

nper is the number of times coupon interest would be paid i.e 20*2=40

pmt is the semiannual coupon interest =$1000*7%*6/12=$35

pv is the current price of bond at $925

fv is the face value of $1000

=rate(40,35,-925,1000)=3.87%

This is the semiannual yield

annual yield =3.87% *2=7.74%

After tax cost of debt=pretax cost of debt*(1-t)

t is the tax rate at 40% or 0.4

after tax cost of debt=7.74% *(1-0.4)=4.64%

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