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Calculating cost of debt

In an effort to raise money, a company sold a bond that now has 20 years of maturity. The bond has a 7% annual coupon which is paid quarterly and it now sells at a price of 1103.58. The bond has a par value of $1000 and can't be called. If the companies tax rate is now 40%, what component of debt should be used in the WACC calculations?

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Please refer attached file for better clarity of formulas used.

Solution:

Coupon amount=(1000*7%/4)=$17.50 quarterly
Current price of bond=$1,103.58
Number of coupon payments left=20*4=80

Let us analyze cash flows from the company's point view

Period Cash flows
0 1103.58
1 -17.5
2 -17.5
3 -17.5
4 -17.5
5 -17.5
6 -17.5
7 -17.5
8 -17.5
9 -17.5
10 -17.5
11 -17.5
12 ...

Solution Summary

The solution describes the steps to calculate cost of debt.

$2.19