Kenny Electric Company's noncallable bonds were issued several years ago and now have 20 years to maturity. These bonds have a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000. If the firm's tax rate is 25%, what is the component cost of debt for use in the WACC calculation

6.35%

Explanation:

Let us as a matter of preference determine the pretax cost of debt using the financial calculator approach as set out below:

N=40 (number of semiannual coupons in 20 years=20*2)

PMT=46.25 (semiannual coupon=face value*coupon rate*6/12=$1000*9.25%*6/12=$46.25 )

PV=-1075( current market price)

FV=1000( face value)

Lastly, enter CPT I/Y=4.23% (semiannual yield)

annual yield=pretax cost of debt=4.23% *2=8.46%

The after-tax cost of debt=8.46% *(1-25%)=6.35%

The after-tax cost of debt for use in WACC calculation=6.35%

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