The Lincoln Company sold a $1,000 par value, noncallable bond several years ago 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 25%.What is the component cost of debt for use in the WACC calculation?

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The component cost of debt for use in the WACC calculation can be found by calculating the yield to maturity (YTM) of the bond, which reflects the return the bond will generate if held to maturity. Given that the bond has a semiannual coupon, the YTM must be calculated on a semiannual basis and then annualized. The YTM can be found using the bond pricing formula or a financial calculator. The correct YTM, considering the bond's current price ($925), par value ($1,000), annual coupon rate (7.00% paid semiannually, so 3.5% per period), and the number of periods (20 years * 2 = 40 periods), is approximately 3.905% per period, which annualizes to about 7.81% (3.905% * 2). However, since interest expense is tax-deductible, the after-tax cost of debt is calculated as YTM * (1 - tax rate). Therefore, the after-tax cost of debt is 7.81% * (1 - 0.25) = 5.81%.

The Lincoln Company Sold a $1,000 Par Value, Noncallable Bond