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.
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. Lenny "Nails" Dykstra, a guy who's used to winning, consistently profits from his deep-in-the-money options calls. You can, too, with his Nails on the Numbers. Try Lenny's service free and see how it works for you. If you decide to subscribe, just one winning call will pay for a whole year!