Net Interest Cost (NIC)
What Is Net Interest Cost (NIC)?
Net interest cost (NIC) is a mathematical formula used to process the overall interest expense of a bond issue. The formula for net interest cost (NIC) depends on the average coupon rate weighted to long periods of maturity and is adjusted for any associated discounts or premiums.
Understanding Net Interest Cost (NIC)
Net interest cost (NIC) is one method that companies use to compare bids from underwriter syndicates. At the point when a company issues a bond- connecting with a pool of investors to loan it money over a predefined period of time in exchange for an installment they for the most part sell them to an organization of underwriters. This brief group of investment banks and representative vendors are then responsible for selling the bonds to the public.
Companies will try to get the best price from underwriters. They need underwriters that produce the least amount of interest costs, the cumulative amount a borrower pays on a debt obligation over the life of the credit. That means that when a debt issuer utilizes the net interest cost (NIC) to assess their underwriter bids, they'll for the most part contract with the organization offering the lowest net interest. This may not be the best method for choosing underwriters as some might have a low net interest cost (NIC), however a higher total interest cost (TIC) over the lifetime of the bond.
Net interest cost (NIC) considers any premium or discount pertinent to the issue (that is, whether the bond is selling above or below face value). It likewise factors in the dollar amount of coupon interest, which is the periodic rate of interest paid by the issuers to its buyers over the life of the bond. Net interest cost (NIC) is communicated as a percentage.
Working out Net Interest Cost (NIC)
The net interest cost (NIC) formula is a simple, direct calculation in light of accessible bond data. The formula is:
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Net Interest Cost (NIC) = (Total Interest Payments + Discount - Premium)/Number of Bond-Year Dollars
NetInterestCost(NIC)=(TotalInterestPayments+Discount−Premium)/NumberofBond−YearDollars ~
The "number of bond-year dollars" equals the sum of the product of every year's maturity value and the number of years to its maturity.
Illustration of Net Interest Cost (NIC)
Company ABC needs to calculate the net interest cost (NIC) on its latest bond issue. In the event that total interest payments on the debt total $4,000,000, the premium was $250,000, and the number of bond-year dollars is $100,000,000, then, at that point, the net interest cost (NIC) formula would be:
Net interest cost = ($4,000,000 - $250,000)/$100,000,000 = .0375 or 3.75%.
Limitations of Net Interest Cost (NIC)
The net interest cost is just one method for registering the overall interest expense of a bond issue. One of its greatest defects is that it doesn't incorporate the time value of money (TMV): the concept that money accessible today is worth more than a similar amount from here on out, due to its potential earning capacity.
To take the time value of money (TMV) viable, it is important to utilize the "true interest cost (TIC)" method. TIC incorporates every single ancillary expense and costs, for example, finance charges, conceivable late fees, discount points, and prepaid interest, alongside factors related to the TMV.
Features
- Net interest cost depends on the average coupon rate weighted to long stretches of maturity and is adjusted for any associated discounts or premiums.
- Debt issuers utilize this formula to assess their underwriter bids, frequently contracting with the organization that is offering the lowest net interest.
- Debt issuers are likewise encouraged to utilize different tactics to decide the quality of an underwriter's bid, particularly as net interest cost doesn't incorporate the time value of money (TMV).
- Net interest cost (NIC) is a mathematical formula that an issuer of bonds uses to process the overall interest expenses that are payable on their bonds.
