The cost of debt begins with the average yield to maturity it pays on its bonds. We multiply that rate by 100% minus its tax rate. Let's look at an example.
(HAL - Get Report)
, which paid off for me several times last year, had $2.586 billion in long-term debt (excluding leases) last December - down slightly from a year earlier.
Halliburton's effective tax rate in 2008 was 38%. So subtracting the tax rate from 100%, we get 62%. We multiply that by 4.131% -- the yield to maturity on its bonds, which expire in October 2010. This gives Halliburton an estimated after-tax cost of debt of 2.6%.
Next, we calculate the debt portion of Halliburton's total capital - or debt plus equity. Halliburton shares ended 2008 at $18.08, giving it a market cap then of $16.2 billion. Adding in long-term debt, total capital at the end of the quarter equaled $18.8 billion. So, long-term debt equaled 13.8% of total capital, while equity made up 86.2%.
In the next step, we would multiply the after-tax cost of debt times the weight of the debt, giving us the debt portion of our equation for the weighted average cost of capital. We'll look at the cost-of-equity side of the equation next week.
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