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To help finance a major expansion, Castro Chemical Company sold a noncallable bond
several years ago that now has 20 years to maturity. This bond has a 9.25% annual
coupon, paid semiannually, sells at a price of $1,025, and has a par value of $1,000. If
the firm's tax rate is 40%, what is the component cost of debt for use in the WACC
calculation? Do not round your intermediate calculations.

Sagot :

abiolataiwo2015

Based on the information given the component cost of debt for use in the WACC  calculation is 5.388%.

First step is to calculate the rate using financial calculator

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

Where:

Nper=20×2=40 years

Pmt=1,000×(9.25%/2)=46.25%

Pv=-$1,025

Fv=$1,000

Rate=4.49%

Hence, the semi-annual cost of debt before tax is 4.49%

Second step is to calculate the annual cost of debt before tax using this formula

Annual cost of debt before tax=Semi-annual cost of debt ×2

Let plug in the formula

Annual cost of debt before tax=4.49%×2

Annual cost of debt before tax=8.98%

Third step is to calculate the annual cost of debt after tax using this formula

Annual cost of debt after tax=Annual cost of debt before tax × (1- Tax rate)

Let plug in the formula

Annual cost of debt after tax=8.98%×(1-.40)

Annual cost of debt after tax=8.98%×.60

Annual cost of debt after tax=5.388%

Inconclusion the component cost of debt for use in the WACC  calculation is 5.388%.

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