Hello Everyone,
Im kinda having a tough time calulating WACC always different yields are avaliable for calculating the cost of debt.
On reading 30 (Long-term liabilities) i learned that the effective yield is the most apropriate method for calculating interest expenses. By that i mean that always a bond is issued at discout or premium to face value, the effective yield will be different than coupon rate.
While doing kaplans Corporate Finance questions, the right answers often uses the coupon rate as interest expense instead of the current yield.
My questions is: Which way is the correct one?
Thanks for the help.
Can’t tell without a specific example, but my guess is that the bond in question is issued at par. In that case, YTM = coupon rate. So, the rule still holds (it’s just that they threw in an additional twist about bonds issued at par).
Well, i cant find the question that brougt me here. But here’s an example question, using Coupon rates instead of current yield to calculate interest expense:
The following information reflects the projected operating results for Opstalan, a catalog printer.
- Sales of $5.0 million.
- Variable Costs at 40% of sales.
- Fixed Costs of $1.0 million.
- Debt interest payments on $1.5 million issued with an annual 7.0% coupon (current yield is 8.0%).
- Tax Rate of 0.0%.
Opstalan’s degree of total leverage (DTL) is closest to:
A) 2.58
B) 1.41
C) 1.59
Anyway, thanks for the answer. I’ll keep looking into it.
Simple to calculate the interest expense you need to use the bond price at the time of issuance
i think you are mistaking YTM for current yield in this example…