Net Interest Cost (NIC)
What it is:
How it works/Example:
The formula for net interest cost is:
Net Interest Cost = (Total Interest Payments + Discount - Premium) / Number of Bond-Year Dollars
The "number of bond-year dollars" equals the sum of the product of each year's maturity value and the number of years to its maturity.
For example, let's assume Company XYZ wants to calculate the NIC on its most recent bond issue. If the 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 using the formula above, the NIC is:
NIC = ($4,000,000 - $250,000) / $100,000,000 = .0375 or 3.75%
NIC is expressed as a percentage. Note that net interest cost does not incorporate the time value of money. To take the time value of money into account, you need to use the "true interest cost" method, also called the "present worth" method.
Why it matters:
When companies issue bonds, they usually sell the bonds to a syndicate of underwriters, who in turn sell the bonds to the public. Thus, companies shop around for the best price from underwriters -- that is, the one that produces the least interest cost over the life of the loan. NIC is used as one way to compare bids from the underwriters. But it's not the only way. Because NIC doesn't incorporate the time value of money, other measures can provide useful information about the quality of an underwriter's bid.