3. Next, we need to calculate MMMs cost of debt. Unfortunately, Thomson ONE doesnt provide a direct...

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3. Next, we need to calculate MMM’s cost of debt. Unfortunately, Thomson ONE doesn’t provide a direct measure of the cost of debt. However, we can use different approaches to estimate it. One approach is to take the company’s longterm interest expense and divide it by the amount of long-term debt. This approach works only if the historical cost of debt equals the yield to maturity in today’s market (that is, only if MMM’s outstanding bonds are trading at close to par). This approach may produce misleading estimates in the years during which MMM issues a significant amount of new debt.

For example, if a company issues a lot of debt at the end of the year, then the full amount of debt will appear on the year-end balance sheet, yet we still may not see a sharp increase in interest expense on the annual income statement because the debt was outstanding for only a small portion of the entire year. When this situation occurs, the estimated cost of debt will likely understate the true cost of debt.

Another approach is to try to find this number in the notes to the company’s annual report by accessing the company’s home page and its Investor Relations section. Remember that you need the after-tax cost of debt to calculate a firm’s WACC, so you will need MMM’s average tax rate (which has been about 37% in recent years). What is your estimate of MMM’s after-tax cost of debt?

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Financial Management Theory And Practice

ISBN: 9781439078105

13th Edition

Authors: Eugene F. Brigham, Michael C. Ehrhardt

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