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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 $1,075, 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?


Select one:


a. 5.08%


b. 4.58%


c. 5.33%


d. 4.35%


e. 4.83%

Answer :

Answer:

A is the correct option ,5.08%

Explanation:

The component cost of debt used in WACC computation is the after tax cost of debt,which is given as :

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

t is the tax rate of 40%

Pretax cost of debt can be computed using the rate formula in excel:

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

nper is number of coupon payments expected from the bond in the remaining 20 years i.e 20*2=40

pmt is the semiannual coupon payment of  $46.25  ($1000*9.25%*6/12)

pv is the current bond price of $1075

fv is the face value of $1,000

=rate(40,46.25,-1075,1000)=4.23%

semiannual rate is 4.23%

annual rate =4.23% *2=8.46%

after tax cost of debt=8.46%*(1-40%)=5.08%

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